CHAPTER 10

202 Quality AssurancePerformance Measurement and Strategic Information Management18

CHAPTER 8Performance Measurement and StrategicInformation ManagementTeaching NotesThis chapter develops facets of measurement and information management. These concepts may be somewhat difficult for students to grasp, at first. This may especially be true if there are accounting or finance majors in the class, or practicing accountants in a seminar. Some of the cost concepts presented in this chapter may disagree with the "conventional" views of traditional accountants and many economists. The concept of accounting for quality costs with a focus on four categories of cost and the balanced scorecard approach may be new or strange to them. Key objectives are:

To focus on the role of measurement as the act of quantifying the performance dimensions of products, services, processes, and other business activities and the use of measures and indicators -- the numerical information that results from measurement. These are key to understanding the broad scope of performance management, based on factual data in the total quality management process. Organizations need performance measures to drive strategies and organizational change, manage resources and operate processes effectively, and continually improve.

To develop the concept of performance measures and the associated needs for data. Organizations need performance measures to drive strategies and organizational change, to manage resources, and to operate processes effectively and continuously improve. Thus, data and information support control, diagnosis, and planning at the three levels of quality.

To develop an appreciation for the balanced scorecard concept that includes the four perspectives of: financial, internal, customer, and innovation and learning perspectives, and typically contains leading and lagging measures that are linked through logical cause-and-effect relationships.

To point out that the Baldrige criteria provide a slightly different view of the balanced scorecard, focusing on six categories of performance measurements and indicators: customer, product and service, financial and market, human resource, organizational effectiveness, and governance and social responsibility measures.

To develop further understanding of the importance of measurement and strategic information in processes by showing the need for comparative and benchmark data which must be used to gain an accurate assessment of performance; and the further need for performance measures and indicators called key business drivers or key success factors that determine what is important to the success of the organization. These must be used by senior leaders for strategic purposes and be aligned with company strategy and be actionable.

To introduce the concept of process-level measures, derived through close examination of the processes that create products and services, and that should be actionable to provide the basis for decisions at the level at which they are applied. Types of process level measurements include nonconformities per unit, defects per unit, errors per opportunity, and dpmo--defects per million opportunities. Many organizations use dashboards, which typically consist of a small set of measures (five or six) that provide a quick summary of process performance.

To categorize the four classes of quality costs as prevention, appraisal, internal failure and external failure and show how they can help to translate quality issues into the language of management -- money.

To define and provide examples of several tools used to measure, analyze, and allocate quality costs, including the relatively new accounting technique of "activity-based" information, or costing.

To introduce a relatively new tool, called return on quality (ROQ) and show how it can be valuable to senior management as a means of justifying quality expenditures and demonstrating their value to senior management.

Organizations must ensure that data are valid and reliable; that is, they measure what they are supposed to consistently, and that employees have access to the data they need to do their jobs. Confidentiality and security are important factors today, particularly with the increased use of electronic data transfer.

To explore the role of knowledge assets -- the intellectual resources that an organization possesses. An important requirement for making use of these assets is to have a process for knowledge management, which can be used to identify, capture, organize, and use knowledge assets to create and sustain competitive advantage. To understand the nature of internal benchmarking, that is the ability to identify and transfer best practices within the organization.

To explore requirements to identify and collect internal knowledge and best practices; share and understand those practices; and how to adapt and apply them to new situations and bring them up to best practice performance levels.

To study how the Baldrige criteria, ISO 9000:2000, and Six Sigma approaches organizations needs to select, gather, analyze, manage, and improve its data, information, and knowledge assets. ISO 9000:2000 provides a basic framework for managing data and information regarding product and process characteristics. Six Sigma emphasizes fact-based decisions, requiring measuring and reporting performance goals, and using performance indicators to control and sustain improvements.

Several of the Baldrige video clips available in the Instructors Resource area on the website for this chapter have scenes pertaining to performance measurement and strategic information management.

ANSWERS TO QUALITY IN PRACTICE KEY ISSUES

Using the Balanced Scorecard at the United States Postal Service1. The Voice of the Employee supports improved internal processes (Voice of the Business), and the Voice of the Business supports customer satisfaction (Voice of the Customer). One of the first areas of emphasis was the Voice of the Employee, which focused on providing a safe and secure workplace in response to instances of violence and poor employee relations. A second major initiative, the Voice of the Business, focused on the Breakthrough Productivity Initiative, while the third area, the Voice of the Customer, focused on providing timely, reliable delivery. In their balanced scorecard work, Kaplan and Norton advocated a well-connected mapping that leads from an organizations main strategy to the four perspectives of the balanced scorecard: Financial, Customer, Internal Process, and Learning and Growth. Each element works to support the strategic objectives in a linked process. Learning and growth (Voice of the Employee in postal terms) supports improved internal processes (Voice of the Business), which support customer satisfaction (Voice of the Customer). Customer satisfaction leads to the desired financial outcome, which in the case of the Postal Service is sufficient revenue to support the universal delivery service mission.

2. Despite significant strides in improving performance, most customers would agree that there is additional room for improvement in customer service by the USPS. This could start with efforts to reduce queue times for customers in post offices across the county. Who hasnt wondered why even small post offices have two or three service positions at their counters, often with only one person to staff them, even during peak periods? An additional metric would be to measure the percentage of miss-delivered mail. Knowledge Management for Continuous Improvement at Convergys1.Convergys has established continuous improvement as part of the companys culture and ties in leadership support, financial relevance and total participation so as to link CI to important strategic business initiatives. The CI Portal has been developed to facilitate sharing of success stories and best practices in order to accelerate improvement efforts. Also, employees are guided by the Portals software on how to submit improvement ideas.

2.This is apparently a two-stage process. Initially improvement ideas must be submitted to the CI Pipeline using the following steps. Then, the improvement has to be submitted and approved as a best practice.

Steps for submission to the CI Pipeline:

Submitter enters improvement and selects Sponsor

Sponsor requests more information

Submitter updates the improvement with more information

Sponsor approves improvement and selects implementation team

Submitter, Sponsor or Team Members enter the success story and Sponsor marks it complete

(Alternately) Sponsor declines sponsorship

Improvements with no activity in 60 days are swept into inactive status

Steps for approval as a best practice

Document potential best practice

Forward to vice president who is the subject matter expert for the area

VP reviews the potential best practice and decides if its use should be encouraged

VP approves it as a best practice

3.Best practices and tools are used to promote learning and develop a knowledge-based organization in a number of ways. Besides facilitating the sharing of best practices, the CI Portal makes it easy to record improvements using a standard format and categorizing them in a way that makes it easy for employees to find information when it is needed. Also, through the CI Portal, resources such as any of the 40 specific improvement tools may be accessed to help facilitate and/or accelerate improvement efforts. In addition, access is provided for employee training on an as-needed basis. Self-paced modules are available on numerous CI topics. Finally, the CI approach has become a part of the corporate culture with high involvement of management as well as line employees, and bottom line impact of higher profit margins than competitors is significant.

ANSWERS TO REVIEW QUESTIONS1. Measurement is the act of quantifying the performance dimensions of products, services, processes, and other business activities.

2. Measures and indicators refer to numerical information that results from measurement. The term indicator is used to define a measurement that is not a direct or exclusive measure of performance, such as, complaints -- an indicator of customer dissatisfaction.

3. Organizations need performance measures for three reasons:

To lead the entire organization in a particular direction; that is, to drive strategies and organizational change

To manage the resources needed to travel in this direction by evaluating the effectiveness of action plans

To operate the processes that make the organization work and continuously improve

Other reasons for measurement, in general, are:

If you dont measure results, you cant tell success from failure

If you cant see success, you cant reward it -- and will probably end up rewarding failure

If you cant recognize failure, you cant correct it.

4. Data at the individual level provide workers with information to continually evaluate and, if necessary, correct the performances of machines and processes. At the process level, data collected through systematic measurement describe process performance and identify areas for improvement. At the organizational level, quality and operational performance data, along with relevant financial data, provide the basis for strategic planning and decision making

5. Good data and information management provide many benefits:

They help the company know that customers are receiving appropriate levels of service because indicators are used to measure service attributes.

They provide concrete feedback to workers to verify their progress.

They establish a basis for reward and recognition.

They provide a means of assessing progress and signaling the need for corrective action.

They reduce the costs of operations through better planning and improvement actions.

6. The leading practices used by companies for successful quality data and information management include:

They develop a comprehensive set of performance indicators that reflect internal and external customer requirements and the key factors that drive the business.

They use comparative information and data to improve overall performance and competitive position.

They involve everyone in measurement activities and use sound analytical methods to support analysis and decision-making.

They ensure that data are reliable, accessible, and widely visible throughout the organization.

They use sound analytical methods to conduct analyses and use the results to support strategic planning and daily decision-making.

They continually refine information sources and their uses within the organization.

7. Robert Kaplan and David Norton of the Harvard Business School in response to the limitations of traditional accounting measures coined the term balanced scorecard. Its purpose is to translate strategy into measures that uniquely communicate your vision to the organization. Their version of the balanced scorecard consists of four perspectives:

Financial Perspective: Measures the ultimate results that the business provides to its shareholders. This includes profitability, revenue growth, return on investment, economic value added (EVA), and shareholder value.

Internal Perspective: Focuses attention on the performance of the key internal processes that drive the business. This includes such measures as quality levels, productivity, cycle time, and cost.

Customer Perspective: Focuses on customer needs and satisfaction as well as market share. This includes service levels, satisfaction ratings, and repeat business.

Innovation and Learning Perspective: Directs attention to the basis of a future successthe organizations people and infrastructure. Key measures might include intellectual assets, employee satisfaction, market innovation, and skills development.

8. A good balanced scorecard contains both leading and lagging measures and indicators. Lagging measures (outcomes) tell what has happened; leading measures (performance drivers) predict what will happen. For example, customer survey results about recent transactions might be a leading indicator for customer retention (a lagging indicator); employee satisfaction might be a leading indicator for turnover, and so on. These measures and indicators should also establish cause-and-effect relationships across perspectives. Understanding such relationships is important in using data and information for strategic and operational decisions.

9. The key categories of results measures for the Malcolm Baldrige Criteria are divided into six sets:

1. Customer

2. Financial and market

3. Human resource

4. Supplier and partner performance

5. Organizational effectiveness.

6. Governance and social responsibility

Relevant measures and indicators of an organizations performance as viewed by customers include direct measures of customer satisfaction and dissatisfaction, customer retention, gains and losses of customers and customer accounts, customer complaints and warranty claims. Other indicators of customer satisfaction include measures of perceived value, loyalty, positive referral, and customer relationship building. Customer satisfaction should be measured over three areas at a minimum: product quality, service quality, and cycle times.

Financial measures are generally tracked by senior leadership to gauge overall company performance and are often used to determine incentive compensation for senior executives. Measures of financial performance might include revenue, return on equity, return on investment, operating profit, pre-tax profit margin, asset utilization, earnings per share, and other liquidity measures. Marketplace performance indicators could include market share, measures of business growth, new product and geographic markets entered, and percentage of new product sales as appropriate.

HR measures can relate to employee well-being, satisfaction, training and development, work system performance, and effectiveness. Examples include safety, absenteeism, turnover, and employee satisfaction. Other measures might include the extent of training, training effectiveness, and measures of improvement in job effectiveness.

Key measures of supplier performance are quality, delivery and service, and price. Quality might be measured by defect rates, complaints, functional performance, reliability, and maintainability.

Organizational effectiveness includes measures and indicators of design, production, delivery and support process performance. Examples of common measures are cycle times, product and service quality, production flexibility, lead times, setup times, time to market, product/process yields, and delivery performance.

Governance and social responsibility should be systematically measured and monitored to maintain an ethical organization that is a good citizen in its communities. Measures and indicators may be related to organizational accountability, stakeholder trust, and ethical behavior. They include measures of regulatory/legal compliance, financial and ethics review results, and measures of community service, such as volunteer hours and presentations to educational or civic groups. Key financial measures that are tied strongly to corporate governance include those found in income statements, balance sheets, as well as distributions of stock and stock options, and management stock purchase and sales activity.

10. Examples of common measures for organizational effectiveness are cycle times, product and service quality, production flexibility, lead times, setup times, time to market, product/process yields, and delivery performance.

Product and service quality indicators focus on the outcomes of manufacturing and service processes. A common indicator of manufacturing quality is the number of nonconformities per unit, or defects per unit. Because of the negative connotation of defect and its potential implications in liability suits, many organizations use the term nonconformity; however, quite a few still use defect. In this text, both terms are used interchangeably to be consistent with current literature and practice. In services, a measure of quality analogous to defects per unit is errors per opportunity. Each customer transaction provides an opportunity for many different types of errors.

Nonconformities per unit or errors per opportunity are often reported as rates per thousand or million. A common measure is dpmo--defects per million opportunities. Thus, a defect rate of 2 per thousand is equivalent to 2,000 dpmo. At some Motorola factories, quality is so good that they measure defects per billion!

Many organizational effectiveness measures focus on process (both core and support) performance. Process data can reflect defect and error rates of intermediate operations, and also efficiency measures such as cost, cycle time, productivity, schedule performance, machine downtime, preventive maintenance activity, rates of problem resolution, energy efficiency, and raw material usage.

Organizational effectiveness measures may also include measures of regulatory/legal compliance and public responsibility.

11. Looking at data without a basis for comparison can easily lead to a false sense of achievement. Organizations need comparative data, such as industry averages, best competitor performance, and world-class benchmarks to gain an accurate assessment of performance. For example, a performance measure may be improving, but at a rate slower than its competition. Without that information, it would be difficult for an organization to recognize the need for further improvements or an accelerated pace of change to close the gap. Comparative and benchmark information also provides the motivation to seek breakthrough improvements.

Comparative data should be driven by an organizations needs and priorities, and focus on areas most critical to competitive strategy. There are many ways to obtain comparative data. These include third party surveys and benchmarking approaches.

12. Many organizations make two fundamental mistakes: (1) not measuring key characteristics critical to company performance or customer satisfaction, and (2) taking irrelevant or inappropriate measurements. In the first case, the organization often fails to meet customer expectations or performance goals. In the second, the measurement system directs attention to areas that are not important to customers, thus wasting time and resources.

13. It is important to link performance measures to strategy. A balanced scorecard approach can help to identify the right measures by aligning them with the organizations vision and strategy. This provides a means of setting targets and allocating resources for short-term planning, communicating strategies, aligning departmental and personal goals to strategies, linking rewards to performance, and supplying feedback for organizational learning.

Effective performance measures that are aligned with business strategy are driven by factors that determine what is important to the success of the business. These include:

1. the nature of a companys products and services

2. major markets

3. principal customers and their key quality and performance requirements

4. organizational culture; its purpose, mission, and vision

5. capabilities and core competencies, such as facilities and technologies

6. supplier and partnering relationships

7. regulatory environment

8. position in market and competitive environment

9. principal factors that determine competitive success, such as product innovation, cost reduction, or productivity growth

10. current business directions, such as new product and market changes and new business alliances

14. The term actionable as it relates to measures and indicators means that key business factors that are strategic elements of a business and that drive all major elements of the quality system must provide a basis for decisions at the level at which they are applied.

Key business factors include:

a. The nature of a company's products and services.

b. Principle customers.

c. Major markets.

d. Key customer quality requirements.

e. Position in market and competitive environment.

f. Facilities and technologies.

g. Suppliers.

h. Regulatory environment.

i. Other factors, such as new company thrusts, industry changes, etc.

15. To determine useful process-level performance measures and indicators, one may use the following steps:

Identify all customers of the system and determine their requirements and expectations.

Define the work process that provides the product or service.

Define the value-adding activities and outputs that compose the process.

Develop performance measures or indicators.

Evaluate the performance measures to insure their usefulness.

16. Cost of quality programs are valuable to managers because it translates poor quality and its results into the language that managers use and understand -- money. It serves purposes such as 1) evaluating the importance of quality problems, 2) identifying areas for cost reduction, 3) aiding in budgeting and cost control activities, and 4) serving as a scoreboard to evaluate the degree of success in achieving quality objectives.

17. The four categories of quality costs are: prevention costs, appraisal costs, internal failure costs, and external failure costs. The first are costs incurred to prevent non-conformance, the second are costs incurred in measurement and data analysis, the third are costs of unsatisfactory quality that is found prior to the product leaving the organization, and the fourth is the cost of allowing defective products or services to be delivered to customers. Examples are training costs in the prevention category, inspection costs in the appraisal category, scrap and rework costs in the internal failure category, and replacement and warranty costs in the external failure category.

18. Index numbers can be used to measure and interpret variations in quality costs. If costs can be collected into each of the four categories (prevention, appraisal, internal and external failure) then they can be related to a relevant base to form a relative index. For example, we could determine the relative cost of quality as a fraction of labor costs, manufacturing costs, or dollars of sales for each appropriate period (month, quarter, or year). By comparing the indices over a period of time, it is possible to determine if quality costs are increasing decreasing, or remaining stable despite changes in levels of the indices or the absolute cost of quality that are reported.

19. Quality costs in services are generally less "uniform" than in manufacturing firms because customers frequently place differing demands for service on the organization, even when they are using the same basic product. Often project costs are collected for customized services and can form the basis for quality cost reporting.

20. Activity-based costing organizes information about the work (or activity) that consumes resources and delivers value in a business. People consuming resources in work ultimately achieve the value that customers pay for. Examples of activities might be moving, inspecting, receiving, shipping, and order processing. To get a handle on these activities, cross-functional teams of workers, managers, and even secretaries map each step of every business process using flowcharts. These flowcharts pinpoint the operations that add value and reveal the ones that do not.

Activity-based costing allocates overhead costs to the products and services that use them. Knowing the costs of activities supports efforts to improve processes. Once activities can be traced to individual products or services, then additional strategic information is made available. The effects of delays and inefficiencies become readily apparent. The company can then focus on reducing these hidden costs

With the new information provided by activity-based costing, managers can make better decisions about product designs, process improvements, pricing, and product mix. Other benefits include the facilitation of continuous improvement activities to reduce overhead costs, and the ease with which relevant costs can be determined.

21. Any measurement is subject to error, and, as a result, the credibility of data can be suspect. A measure is valid if it measures what it says it measures. Reliability of a measurement refers to how well the measuring instrument--manual instruments, automated equipment, or surveys and questionnaires--consistently measures the true value of the characteristic. Measurement reliability in manufacturing demands careful attention to metrology, the science of measurement.

22. Traditionally, measuring reductions in quality-related costs through COQ was the principal method of documenting the benefits of quality. However, this approach only focuses on the internal view of quality. More attention has been paid recently to the external view accounting for increases in revenues associated with improved customer satisfaction. Balancing quality costs against expected revenue gains has become known as ROQ return on quality. ROQ is based on four main principles.

1. Quality is an investment

2. Quality efforts must be made financially accountable

3. It is possible to spend too much on quality

4. Not all quality expenditures are equally valid

23. A company's efforts are wasted if collected data are not available to the right employees when needed. In most companies, data are accessible to top managers and others on a need-to-know basis. In TQ-focused companies, quality-related data are accessible to everyone. Many companies accomplish this through on-line computer networks supplemented by local processing capabilities.

24. Data related to quality, customers, and operational performance support both operational-level decision making and strategic planning. Data can be analyzed using many different types of descriptive statistical techniques and charts to identify trends over time, compare performance among business units, and show comparisons with key benchmarks. The capabilities of todays spreadsheet and database software, such as Microsoft Excel and Access, make this simple to do by nearly any employee. However, volumes of data acquired at the process level, while useful for daily operations, generally are not appropriate for senior executive review. Organizations need a process for transforming data, usually in some integrated fashion, into information that top management can understand and work with. For instance, some companies develop an aggregate customer satisfaction index (CSI) by weighting satisfaction results, market share, and gains or losses of customers.

25. Interlinking is the term that describes the quantitative modeling of cause and effect relationships between external and internal performance criteria--such as the relationship of customer satisfaction measures to internal process measures. Examples are provided in the text.

26. Category 4 of the 2006 Malcolm Baldrige National Quality Award Criteria for Performance Excellence (see the Bonus Materials on the Student CD-ROM for Chapter 3) is titled Information and Analysis. This category examines an organizations performance measurement system and how the organization analyzes performance data and information.

Item 4.1, Measurement, Analysis and Review of Organizational Performance, focuses on the major components of an effective performance measurement system. It addresses an organizations selection, alignment, and integration of data and information for tracking performance in support of organizational objectives and action plans.

The criteria ask organizational leaders to describe how the organization measures, analyzes, aligns, reviews, and improves its performance data and information at all levels and in all parts of the organization.

The criteria also ask how an organization selects and uses comparative data and information to support operational and strategic decision-making and innovation. In addition, the criteria ask what analyses are used to support senior leaders assessment of overall organizational performance and strategic planning, how results are translated into priorities for continuous and breakthrough improvement and into opportunities for innovation, how results are communicated throughout the organization and to suppliers and stakeholders, and how the performance measurement system is kept current with changing business needs and directions.

Item 4.2, Information and Knowledge Management, looks at how an organization ensures the availability of high-quality, timely data and information for all key users employees, suppliers and partners, and customers. It also asks how the organization builds and manages its knowledge assets. This includes ensuring that data, information, and organizational knowledge have all the characteristics that users expect: integrity, reliability, accuracy, timeliness, and appropriate levels of security and confidentiality. In addition, the criteria ask how an organization ensures that hardware systems and software are reliable, secure, and user friendly so that access is facilitated and encouraged, while also ensuring the availability of hardware and software systems, in the event of an emergency. It also addresses how an organization builds and manages its knowledge assets to improve organizational efficiency, effectiveness, and innovation by capturing, protecting, and disseminating organizational knowledge.

In a similar way, ISO 9000:2000 provides a basic framework for managing data and information. The documentation and data control requirements of ISO 9000 require companies to define a process for ensuring that any critical information that is required for the performance of a business process is accurate, up-to-date, and effective for its intended purpose. ISO 9000 places an emphasis on processes that, in many cases are cross functional in nature, it forces companies to break down some of the organizational and functional silos that inhibit effective sharing of information. The Measurement, Analysis and Improvement requirements of ISO 9000:2000 deal with the measurement of product and process characteristics, performance of the quality system, and search for continuous improvement, requiring that management make decisions based on analysis and trends of product and process performance indicators, internal auditing, and customer feedback. Specific requirements include

Establishing, planning, and implementing measurement, monitoring, and improvement activities

Monitoring information about customer satisfactions as a performance metric

Establishing measurement and monitoring methods to assure that product and process requirements are attained

Acquiring and analyzing data to determine improvement effectiveness

Promoting continuous improvement using auditing reports, data analysis, and management reviews.

Six Sigma emphasizes fact-based decisions and provides organizations with tools to generate measurable results from Six Sigma projects. Six Sigma methodology requires measuring and reporting performance goals, and using performance indicators to control and sustain improvements. Project selection is based on understanding the financial as well as the non-financial benefits to the organization, such as cost savings, increased sales, reduced cycle times, or improved customer satisfaction. Thus, measurements are vital in selling Six Sigma projects to top management. Six Sigma can also have a significant impact on the cost of quality because of its focus on financial return. Many Six Sigma projects focus on reducing the costs of poor quality that result from low sigma levels of performance and improved designs that will increase customer satisfaction and hence, revenue. The different categories of the cost of quality described earlier in this chapter provide many opportunities for Six Sigma projects.

ANSWERS TO DISCUSSION QUESTIONS1. The answers to this question could provoke a lively debate in a class. For many items on the list in Figure 8.3, there are joint responsibilities. If the philosophy is held that quality is everybodys job, then a process owner must be found to follow up on both process improvements and individual performer empowerment and responsibility. Therefore, the following table is meant to suggest the appropriate level of focus. Other measurements can be developed and discussed by individual students. If they work either part-time or full time in organizations, they could be encouraged to discuss what measures are used in their organizations.

Level of Quality

Organization ProcessPerformerCustomer-Related MeasuresPerceived valueX

Overall satisfactionXX

Complaints

XX

Gains and losses of customersXX

Customer awards/recognitionsXX

Product and Service Measures

Internal quality measurements

XX

Field performance of products

XX

Defect levels

XX

Response time

XX

Customer ratings of prod/service performance XXX

Financial and Market Measures

Return on equityXX

Return on investmentXX

Operating profitXX

Earnings per shareX

Human Resource MeasuresAbsenteeism

XX

Turnover XXX

Employee satisfaction XX

Training effectiveness

XX

Grievances XXX

Suggestion rates XXX

Safety XXX

Organizational EffectivenessProduction flexibility XX

Lead times XX

Six Sigma initiative results XXX

Innovation rates & time to market XX

Product & process yields XXX

Productivity

XX

Cycle time

XX

Supply chain effectiveness XX

ISO 9000 audit results XXX

Indicators of strategic goal achievement XX

Environmental improvements XX

Governance and Social Responsibility Measures

Environmental and regulatory complianceXX

Community service XXX

Financial and ethics audit resultsX

2. The measurements listed can be classified under the following perspectives of the balanced scorecard:

j. On-time delivery -- Customer perspective

k. Next product generation --Innovation and learning perspective

l. Manufacturing yield -- Internal perspective

m. Engineering efficiency -- Internal perspective

n. Quarterly sales -- Financial perspective

o. Percent of product = 70 -- Financial perspective

p. Cash flow -- Financial perspective

q. Customer partnerships -- Customer perspective and/or innovation and learning perspective

r. Increase market share -- Financial perspective and/or innovation and learning perspective

s. Unit costs of products -- Internal perspective

3. SWOT (strengths, weaknesses, opportunities, and threats) analysis might be used to identify measures in a balanced scorecard by concentrating on the strategic issues that the company faces and how can those be measured and improved. For example, if surveys show that customers perceive that the companys products are not well-designed and are of inferior quality compared to competitors, the firm has a strategic issue to deal with. Questions that might be asked are: how are our designs inferior? What are the critical quality dimensions that the customer demands? And how might we make improvements and hold the gains? This would lead to balanced scorecard measures for design quality and performance quality for each product or product line. 4. Without going into all of the problems of what is wrong with course and instructor evaluations, it can be said that at least four major flaws are common in most systems, as well-intended as they may be: a) they typically lack customer (student) input and customer focus; b) they are too general and fail to take into account the mission or objectives of the course, department, college or university; c) only in rare cases have their validity and reliability been statistically shown; and d) evaluations do not typically focus on improvement.

Most university departments keep many statistics, but have few customer-oriented measurement systems in place. It is not uncommon for universities to know exactly how many students they graduate each year, but to have no information on how many have obtained jobs. Admissions departments can tell how many students they have admitted, but are unable to tell how long it takes for the admission decision to be made (sometimes months after the completed application and paperwork has been received).

5. A number of measures might be discussed in answer to this question. For example, "Time to market" is a statistic that many businesses have concerns about. Statistics indicate that it takes an average of about five years for the typical student to obtain an undergraduate degree in the U.S. Can that cycle time be reduced by better sequencing, reducing overlap between courses, cutting out unnecessary requirements, and better advising to ensure that students take full loads and don't switch majors every few semesters? These are questions that better use of measurement might throw light on, so that related organizational, process, and individual problems could be solved.

6. Answers will vary, depending on the experience and interests of the students in fraternities or student organizations. However, some obvious categories of financial measures, recruiting and retention measures, service to members and community, and academic and competitive excellence come to mind. Financial measures might include standards for non-profit organizations, such as good accounting practices, balanced books, contingency reserve levels, etc. Recruiting and retention would include numbers of recruits pledged as a percentage of those being recruited and numbers (percentages) retained and inducted of those pledged. Service would include numbers, types, and success rates of service activities. Academic and competitive excellence could be measured by overall grade-point averages segmented by class level and major, with comparisons with similar fraternities and sororities. 7. In the cheese-making process, customer requirements of full weight, wholesomeness (lack of contamination, excessive chemical additives, or inferior content, such as excessive water), smell and taste might all be customer related measures that could be interlinked with internal measures.

8. This question refers to the IBM Rochester questions that are asked about process measures. To answer these questions, the following sources would have to be consulted:

Mission support: refer to strategic plan and trace through action plans to the measure.

Management of change: determine if similar measures have resulted in change in the past.

Customer importance: consult with customers to determine if measure is/will be meaningful.

Effectively measure performance: determine what outcomes/results are measured.

Effectively forecast results: determine if measure has a predictive capability.

Easy to understand: ask users to explain what the measure means to them.

Cost effective: estimate current/future costs before making the measure permanent.

Valid, has integrity, timely: determine how the measure is constituted, has it been tested, how long does it take to gather and process required data?

Measurement owner identified: after he/she is identified, ask the person to participate in validating/obtaining answers to the above questions.

9. Answers will vary here depending on the students observations and experience and on which quality cost categories apply to the individual college or university in question. For example, prevention costs might include costs of training guidance councilors about various majors so that students are not mis-advised on course requirements and sequencing. Appraisal costs include costs of testing students in various courses, for public speaking proficiency, or senior comprehensive testing. Internal failure costs occur when a student fails a course and must repeat it. External failure costs are incurred when a student takes a co-op job after taking a course in quality management, but doesnt know how to construct a control chart, so ends up making costly errors in measuring quality at the employers plant. Measurement of some of these costs could be made based on direct costs (such as the cost of a counselor training class). The most difficult measurement would be for the external failure cost. Maybe the university would have to issue a recall for students who took the quality course, but didnt learn the method for making a control chart, due to faulty software in a computer program!

10. Juran, Crosby, and Deming are all correct, based on their own perspectives. Juran and Crosby focus on the tangible costs of internal failure, appraisal, and prevention costs, many of which can be objectively measured. Although some external failure costs such as the cost of a product recall, can be measured, the cost of loss of customers, and even some internal failure costs, such as losses from poor employee morale and fear, can never be measured.

11. This is one of those "gray areas" that depend on the situation. Managers typically want to know the justification for an expensive purchase of equipment, whether it is quantitative or qualitative. Thus, a quality department will probably have to "manage by facts" in their requests. They must be prepared to answer such questions as: What "quantitative" information do you have that tells you that competitors have this testing capability? What are the costs versus benefits of the proposed purchase in quantitative and in qualitative terms?

12. Statistics or quantitative methods can have numerous applications in analyzing performance data. They include the 7 Tools, mentioned earlier, which can be used for graphical analysis of day to day performance, up to very powerful techniques, such as material resource planning (MRP and variations) and linear programming. In particular, Pareto charts, histograms, linear regression, and control charts are useful. Resource allocation can be done using linear programming techniques. Enterprise resource planning (ERP) provides both modeling and feedback capabilities to map process measurements and track them on a continuing basis.

13. As suggested in the answer to review question 26, above, Six Sigma can also have a significant impact on the cost of quality because of its focus on financial return. An organization that adopts the Six Sigma philosophy may wish to routinely gather information that will be useful to financial evaluation of process and projects, for example. Since Six Sigma projects often focus on reducing the costs of poor quality that result from low sigma levels of performance and improved designs that will increase customer satisfaction and revenue this can be worth the time and effort involved in capturing such information.

14.For a hospitals strategic priorities of:

Patient accessibility

Patient safety

Clinical excellence

Few hassles for patients and families

Workforce well-being

Family-centered care

Operational efficiency

For all of these priorities, the measures that might be used are dependent on how each priority is defined. For example, patient accessibility may refer to doctors, staff, or medical testing procedures or facilities within the hospital. Relating to facilities, patient access to digital imaging may be measured by average waiting time after the tests have been ordered. Patient safety concerning drugs could be measured by defects per million opportunities in providing the correct drugs and dosages. Clinical excellence could be measured by rate of readmissions for the same illness or injury. Fewer hassles for patients and families might be measured by reducing patient/family complaints. Workforce well-being could be measured by attitudes on employee satisfaction surveys, as well as by absenteeism and turnover rates. Family-centered care could be measured by satisfaction surveys. Operational efficiency can be measured in countless ways, including cleanliness of rooms, improvements in inventory levels and control, etc.SOLUTIONS TO PROBLEMS

1.The rate of baggage mishandling reported by the Department of Transportation in the United States was 3.75 per 1,000 passengers. If the average number of checked bags per passenger is now 1.3, how many defects per million opportunities (DPMO) does this represent? How does this compare with the rate given in the chapter better or worse? Answer

1. dpmo = (Number of defects discovered) /opportunities for error x 1,000,000

Thus, a defect rate of 3.75 per 1,000 is equivalent to 3,750 dpmo if each passenger only had one bag. However, customers may have different numbers of bags; thus the number of opportunities for error must be based on the average number of bags per customer. If the average number of bags per customer is 1.3, and the airline recorded 3.75 lost bags for 1000 passengers in a month, then

dpmo = 3.75/[1,000)(1.3)] x 1,000,000 = 2884.6

This number is considerably worse than the 234.375 hypothesized in the body of the chapter.

2.Analyze the cost data in the Excel workbook C8Data.xls for the Costcutin Co. What percent of sales are represented by each category of cost? What are the implications of these data for management?Answer

2. Original Data:

Product

A B C

Total sales$1,537,280$ 933,600$1,397,120

Total quality costs

as % of sales 21% 18%12%

External failure30%19%10%

Internal failure55%31%28%

Appraisal11%39%36%

Prevention4%11%26%

(Bold figures represent percentages of quality costs by product.)

The values for percentages of Costcutins sales attributable to quality costs are the index base for the three products A, B, and C and their cost categories. However, because no time-phased data per product were provided, no trend can be established for various product indexes.

Comparison of the data shows that both internal and external failure costs appear to be very high for product A, internal failure cost and appraisal costs appear to be high for product B in comparison to prevention costs, and internal failure, appraisal, and prevention costs appear to be converging for product C. However, product C does have a much lower total cost of quality as a percent of total sales. Managers of all product lines should put more emphasis on prevention and attempt to reduce costs in other categories. Also, they should determine what methods are being used in product C to keep the cost of quality low. Further analysis could be done by analyzing the differences between the processes and the characteristics of the products. Because of high internal and external failure costs product A should have first priority for improvement. (See spreadsheet Prob8-02.xls for details).Costcutin Company

$ 000's

$Qual. Cost - A$Qual. Cost - B$Qual. Cost - C

External failure $ 96.85 $ 31.93 $ 16.77

Internal failure $ 177.56 $ 52.09 $ 46.94

Appraisal $ 35.51 $ 65.54 $ 60.36

Prevention $ 12.91 $ 18.49 $ 43.59

3. Imagimatrix, which designs prototype components for the computer gaming industry has begun a quality program. About a year ago, for the first time, they began to measure quality costs. They were so shocked by their initial figure of 60 percent internal and external failure costs that they immediately launched a Six Sigma quality improvement effort. The percentage of total quality costs recently, after six months of improvements for the firm, are distributed as follows:

Prevention 20%

Appraisal 33%

Internal failure 32%

External failure 15%

What conclusions can you reach from these data?

Answer

3. The general conclusion that can be reached for Imagimatrix from inspecting the data is that costs for internal and external failure are larger than they should be (totaling 47% of quality costs). Improvements that have been made to date have probably involved increasing prevention and appraisal costs that now stand at more than 50% of the total quality costs. Since appraisal costs are a large percentage of costs, and internal failures are a larger percentage than external failures, it is likely that quality is being inspected in, and many defective items are being taken out and reworked after being caught by inspection. More money and time needs to be invested in prevention, which will reduce defects and costs in other areas in a fairly short time.

4.

Analyze the quality cost information by computing a sales dollar base index for Farwest Sales, Inc., in the Excel workbook C8Data.xls. Prepare a memo to management explaining your findings and conclusions.Answer

4. Original Data:

Quarterly Costs (in thousands of dollars)

1234

Total sales 5120.05206.05544.05106.0

External failure 290.8218.2152.8120.6

Internal failure 478.2382.4284.4166.4

Appraisal 199.2227.7284.4276.2

Prevention 29.432.255.295.2

Total quality costs 997.6860.5776.8658.4

Quality costs - % of sales19.516.514.012.9

The composite index for quality costs for Farwest Sales shows a steady decrease in total quality cost down from 19.5% to 12.9% (in other words, $0.195 to $0.129/total sales dollars. Internal failure rates were reduced substantially, from $478.2 thousand in the first quarter to $166.40 thousand in the fourth quarter. External failure rates also showed substantial improvement since the first quarter, dropping from $290.8 thousand to $120.60 thousand in the fourth quarter. Increases in prevention and appraisal expenditures have apparently led to improvements in failure costs. The overall quality index, mentioned above, fell by one-third (19.5 12.89 = 6.59 percentage points). Management should maintain or increase the level of prevention and appraisal in an effort to reduce quality costs, especially failure costs. (See spreadsheet Prob8-04.xls for more details).INDEX OF QUALITY COSTS AS % OF SALES

1 Qtr.2 Qtr.3 Qtr.4 Qtr.

External failure5.684.192.762.36

Internal failure9.347.355.133.26

Appraisal3.894.375.135.41

Prevention0.570.621.001.86

Total Quality Cost19.4816.5314.0112.89

% Total Sales/Base100.00101.68108.2899.73

5. Analyze the cost data in the Excel workbook C8Data.xls for Product B. What are the implications of these data for management? Chart these data. Calculate the quality indices as a relationship to the cost of sales. How do these data differ from those given in Problem 2?

Answer

5. Original Data:

Product B

1 Qtr2 Qtr3 Qtr

Total sales$1,000,000$900,000$1,200,000

Quality Categories as a % of Quality Cost

External failure37%18%

11%

Internal failure19%28%24%

Appraisal42%46%40%

Prevention2%8%25%Total quality costs$210,000$162,000$144,000

(Bold figures represent percentages of quality costs by product.)

As shown in the chart below, details are presented on Product B sales and cost of quality from the problem, along with information on the percentage of total quality cost attributable to each cost category (external, internal, appraisal and prevention). This problem contains time-phased data, unlike problem 2. Thus it is possible to calculate an index base and quarterly indices for the various cost categories. The data show that the external and internal failure indices, as well as the appraisal index are declining, while the prevention index is increasing. The overall quality cost index as a percent of sales is also declining. This is an ideal situation in which manager of the B product line are continuing to put more emphasis on prevention and attempting to reduce costs in other categories. (See spreadsheet Prob8-05.xls for more details).

Qual. Indices as a % of Sales

1 Qtr.2 Qtr.3 Qtr.

External failure0.07770.03240.0132

Internal failure0.03990.05040.0288

Appraisal0.08820.08280.0480

Prevention0.00420.01440.0300

Total Index0.2100.1800.120

$Qual. Cost - 1 Q.$Qual. Cost - 2 Q.$Qual. Cost - 3 Q.

77,70029,16015,840

39,90045,36034,560

88,20074,52057,600

4,20012,96036,000

6. Analyze the cost data from ABEC Corp in the Excel workbook C8Data.xls. What are the implications of these data for management? How do these data differ from those in problem 5?Answer

6. Original Data: Product

A B C

Total sales$2,500, 000 $1,800,000$2,600,000

Quality cost as a % of sales 30 20 25

External failure35%23%13%

Internal failure45%22%30%

Appraisal16%48%40%

Prevention4%7%17%

(Bold figures represent percentages of quality costs by product.)

The following table and chart for ABEC, below, show that total quality costs as a percent of sales ranges from very high to moderate between products. This problem does not contain time-phased data, unlike problem 4. It shows comparisons between products, similar to problem 1. Internal and external failure costs are large for product A, because little appraisal or prevention is done. For product B, defects are being screened out, causing much higher appraisal costs, in total and as a percent of quality costs. However, this method does reduce overall quality costs as a percent of sales (20%) somewhat. Product C attained a good balance among quality cost categories, although a larger percentage of prevention costs might prove to be advantageous. (See Excel spreadsheet Prob8-05 for more details).

SALES AND QUALITY COSTS - $Millions

Total Sales $2.500 $1.800 $2.600

x% Quality Costs 30%20%25%

Product AProduct BProduct CProduct AProduct BProduct C

External failure$0.263$0.083$0.08535%23%13%

Internal failure$0.338$0.079$0.19545%22%30%

Appraisal$0.120$0.173$0.26016%48%40%

Prevention$0.030$0.025$0.1114%7%17%

Total Qual. Cost$0.750$0.360$0.650

7. D.B. Smith Company recycles computers. It buys them and salvages parts and materials from the obsolete systems. It considers that it has done a quality job if it can salvage 60 percent of the book value of equipment that it buys. The book value of a particular lot that it bought was $1,700,000. What conclusions can be drawn from the cost data incurred in processing the lot, as found in the Excel workbook C8Data.xls? Customer returns are simply scrapped and replaced. Be sure and specify your assumptions about categories of quality costs.

Answer

7. Original Data:

Cost Category

Amount

Quality equipment design

$ 23,000

Scrap

325,000

Inspection and test

300,000

Customer returns

95,000

Supplier quality surveys 7,000

Repair

75,000

Note to instructorIf you think that students might have difficulty determining the cost categories, the following might be asked in order to guide their thinking: How would you categorize the costs identified in the data? What is the total cost of quality? Did D.B. Smith Co. meet their goal?

The data can be rearranged, as follows:

Type of Cost

Cost Category $Cost% of COQ

Scrap

Int. failure325,00039.4

Inspection and test

Appraisal

300,000

36.4

Customer returns

Ext. failure 95,000 11.5

Repair

Int. failure 75,000 9.1

Quality equipment design

Prevention 23,000 2.8

Supplier quality surveys

Prevention 7,000 0.8

$ Costs% of COQ

Internal failure4000000.485

External failure950000.115

Appraisal3000000.364

Prevention300000.036

$825,000

Although scrap is part of the process, Smith Company needs to minimize the amount of scrap produced, just as if it were making a product. The total cost of quality is $825,000. Although the categories are not completely clear, the assumed categories are listed in the revised table, above. Internal failure (scrap and repair) total 48.5% of quality costs and external failure in the form of customer returns adds another 11.5%. Only 3.6 % of total costs are being applied to prevention. Apparently, based on high internal failure and appraisal costs, this organization is attempting to screen out bad product and scrap or repair it. Also, on this batch, they didnt accomplish their goal of 60% of book value goal, since (1,700,000 825,000)/ 1,700,000 = 51.47 %. (See spreadsheet Prob8-07.xls for more details).

8.Prepare a chart showing the different quality cost categories and percentages for the Great Press Printing Company. See the data in the Excel workbook C8Data.xls.

Answer

8. Original Data:

Cost Element

Amount

Customer complaint remakes $ 27,000

Printing plate revisions 28,000

Quality improvement projects 13,000

Gauging

100,000

Other waste 38,000

Correction of typographical errors 210,000

Proofreading 450,000

Quality planning 56,000

Press downtime 285,000

Bindery waste 51,000

Checking and inspection 42,000

The spreadsheet data and pie chart (see spreadsheet Prob8-07.xls for details) for the Great Press Printing Company show that the company may be spending too much on appraisal and internal failure cost and too little on prevention. Improvement efforts should concentrate on the categories of proofreading, press downtime and correction of typos.

Cost ElementCategoriesAmount

Customer complaint remakes Ext. fail.$ 27,000

Printing plate revisions Int. fail. 28,000

Quality improvement projects Prev. 13,000

GaugingAppr. 100,000

Other wasteInt. fail. 38,000

Correction of typographical errorsInt. fail. 210,000

ProofreadingAppr. 450,000

Quality planningPrev. 56,000

Press downtimeInt. fail. 285,000

Bindery wasteInt. fail. 51,000

Checking and inspectionAppr. 42,000

GREAT PRESS$000's QUALITY COSTS

PRINTING COMPANY

External failure27,000

Internal failure612,000

Appraisal592,000

Prevention69,000

Total Quality Cost1,300,000

PERCENTAGE OF COSTS

External failure2.08

Internal failure47.08

Appraisal45.54

Prevention5.31

Total Quality Cost100.00

9.Compute a labor cost base index for Miami Valley Aircraft Service Co. to analyze the quality cost information and prepare a memo to management explaining your conclusions. See the data in the Excel workbook C8Data.xls.

Answer

9. Original data:

Quarterly Costs (in thousands of dollars)

1 2 3 4

External failure

1000

900

950

725Internal failure

3,500

3,250

2,900

2,200Appraisal

900

1,200

1,550

800Prevention

400

500

650

800Total Quality Cost

5,800

5,850

6,050

4,525Total Labor Cost

19,500

18,000

23,000

19,000

Miami Valley Aircraft Service Companys data show a decreasing total quality cost index as a percent of labor costs (except for a slight rise in the 2nd quarter), with significant decreases in internal failure costs, possibly due to a concerted quality effort. The decrease in both internal and external quality costs, as a percentage of total quality and labor costs, while the prevention costs percentage is rising, is good. The recommendations would be to increase prevention costs even more rapidly, while holding the line on appraisal costs (see spreadsheet Prob8-09.xls for details) and to concentrate on projects especially aimed at external failure, which has not decreased as rapidly as internal failure costs. However, the caution is that doing so may increase total quality costs in the short run, as may have happened in the 2nd quarter.PERCENTAGES QTRLY. QUALITY/LABOR COSTS

1 Qtr.2 Qtr.3 Qtr.4 Qtr.

External failure5.135.004.133.82

Internal failure17.9518.0612.6111.58

Appraisal4.626.676.744.21

Prevention2.052.782.834.21

Total Quality/Labor Cost 29.7432.5026.3023.82

10.The cost of quality data collected at the installment loan department of the McCutcheon Bank can be found in the Excel workbook C8Data.xls. Classify these data into the appropriate cost of quality categories and analyze the results. What suggestions would you make to management?Answer

10. Original Data:Loan Processing

1.

Run credit checks:

$2,675.01

2.

Review documents:

$3,000.63

3.

Make document corrections; gather additional information:

$1,032.65

4.

Prepare tickler file; review and follow up on titles,

insurance, second meetings:

$ 155.75

5.

Review all output:

$2,243.62

6.

Correct rejects and incorrect output:

$425.00

7.

Reconcile incomplete collateral report:

$78.34

8.

Handle dealer problem calls; address associate problems;

research and communicate information:

$2,500.00

9.

Compensate for system downtime:

$519.01

10.

Conduct training:

$1,500.00

Loan Payment

1.

Receive, inspect, and process payments:

$800.00

2.

Respond to inquiries when no coupon is presented with payments: $829.65

Loan Payoff

1.

Receive, inspect, and process payoff and release documents: $224.99

2.

Research payoff problems:

$ 15.35

For the McCutcheon Bank, a detailed report might be prepared by an internal or external quality consultant to the bank as follows:

Quality Cost Categories

Cost Elements

Costs

Subtotal

Proportion

APPRAISAL

1. Run credit checks

2675.01

Loan Payment & Loan Payoffs1. Receive, inspect,

& process documents (2 items)1024.99

$ 3700.00

Quality Cost Categories

Cost Elements

Costs

Subtotal

Proportion

Inspection

2. Review documents

3000.63

4. Prepare tickler file, etc.

155.75

5. Review all output

2243.62

$ 5400.00

Total Appraisal Cost

$ 9100.00

0.569

PREVENTION

10. Conduct training

1500.00

Total Prevention Cost

$ 1500.00 0.094

INTERNAL FAILURE COSTS

Scrap and Rework

3. Make document corrections

1032.65

6. Correct rejects

425.00

7. Reconcile incomplete collateral

reports

78.34

9. Compensate for system downtime 519.01

$ 2055.00

Loan Payment or Payoff

2. Respond to inquiries - no coupon 829.65

2. Research payoff problems 15.35

$ 845.00

Total Internal Failure Cost

$ 2900.00 0.181

EXTERNAL FAILURE COSTS

8. Handle dealer problem calls, etc. 2500.00

$ 2500.00 0.156

Total costs

$16000.00

Analysis:

As one would hope, the external failure costs for the bank are not extremely high at $2500.00. However, they do represent 15.6% of the total quality costs. The process of working with dealers should be investigated to determine whether it can be simplified, better communications established, and problems avoided in the future.

The highest cost category is in appraisal costs at $ 9,100.00 and 56.9% of total quality costs. If the categories of "document review" and "review all output" can be reduced without compromising the quality of the lending procedure, these costs could be greatly improved.

The largest internal failure costs are being incurred in the document correction and "Respond to inquiries - no coupon areas." A fairly substantial cost of quality for the "Compensate for system downtime" category. These areas should be investigated to determine whether procedures could be improved in order to reduce costs.

In the prevention area, it appears that not much attention is being given to the need for this activity, since only 9.4% of quality costs are for prevention. If training could be given in quality improvement techniques, as well as time spent on quality planning and improvement, then the other cost categories might be reduced with only a modest increase in prevention costs.11. Repack Solutions, Inc. has a distribution center in Cincinnati where it receives and breaks down bulk orders from suppliers factories, and ships out products to retail customers. Prepare a chart showing the different quality cost categories and percentages for the companys quality costs that were incurred over the past year. See the Excel workbook C8Data.xls for the data.

Answer

11. Original Data:

Cost Element

Amount

Checking outbound boxes for errors

$710,000

Quality planning

12,000

Downtime due to conveyor/computer problems

400,000

Packaging waste

80,000

Incoming product inspection

60,000

Customer complaint rework

40,000

Correcting erroneous orders before shipping

43,000

Quality training of associates

30,000

Quality improvement projects

20,000

Other waste

42,000

Correction of typographical errors--pick tickets

13,000

Total Quality Cost $1,450,000

Spreadsheet data and the Pareto chart (see Prob8-11.xls for details) for Repack Solutions, Inc. show that the company is spending too much on appraisal and internal failure cost and too little on prevention. Checking boxes, machine downtime, and packaging waste need immediate improvement in order to have the greatest impact on quality costs, since they constitute almost 82% of quality costs. However, it should be done with caution, since checking boxes represents appraisal costs designed to screen out poor quality and prevent it from reaching the customer.

REPACK SOLUTIONS, INC.

QUALITY COST & PERCENTAGES

Quality Cost

PercentCumulative %CostCategory

Checking boxes48.9748.97710,000Appraisal

Pkg. waste27.5976.55400,000Int. Fail.

Income. insp.5.5282.0780,000Appraisal

Other waste4.1486.2160,000Int. Fail.

Error corrn.2.9789.1743,000Int. Fail.

Typo corrn.2.9092.0742,000Int. Fail.

Cust. complaints2.7694.8340,000Ext. Fail.

Qual. train. assoc.2.0796.9030,000Prevent.

Improv. proj.1.3898.2820,000Prevent.

Quality planning0.9099.1713,000Prevent.

Mach. downtime0.83100.0012,000Int. Fail.

Total1,450,000

Note that costs could also be classified by aggregating them into the four categories of internal and external failure, prevention and appraisal costs, instead of the above categories.

12.Use Pareto analysis to investigate the quality losses at Nosoco Paper Mill. What conclusions do you reach? See the Excel workbook C8Data.xls for the data.

Answer

12. Original Data

Category

Annual Loss

Downtime

$ 28,000

Testing costs

12,000

Rejected paper

373,000

Odd lot

66,000

Excess inspection

21,000

Customer complaints

103,000

Wasted materials

39,000

Quality improvement training

8,000

Total Quality Cost $650,000

See the following table and figure for Pareto analysis of Nosocos quality cost categories. See spreadsheet Prob8-12.xls for details.

Nosoco Paper Company

Quality Costs and Percentages

PercentCumulative %Cost

Rejected paper 57.38%57.38%373,000

Customer complaints 15.85%73.23%103,000

Odd lot 10.15%83.38%66,000

Wasted materials6.00%89.38%39,000

Downtime 4.31%93.69%28,000

Excess inspection 3.23%96.92%21,000

Testing costs 1.85%98.77%12,000

Quality Imprv. Trng.1.23%100.00%8,000

Total Costs650,000

Conclusion: Nosoco Paper Co. is experiencing problems in two major categories: rejected paper and customer complaints. These categories, which could be related to each other, account for 73.23 percent of their quality costs. Rejected paper (in paper manufacturing, paper is sometimes rejected due to various internal manufacturing problems) suggests a possible technical problem in the chemistry of the materials or paper machine adjustments. If customers perceive that the paper does not meet their requirements then the causes need to be determined, as well. Thus, it may be recommended that two improvement teams be formed, but that they coordinate closely to work on these areas. After these problems have been eliminated, then work could begin on addressing the next two defect areas.

Note that costs could also be classified into the four categories of internal and external failure, prevention and appraisal costs, instead of the above categories. However, this type of aggregation would cover up the major categories, since one falls into the internal failure and the other into external failure costs.

13.Given the cost elements in the Excel workbook C8Data.xls, determine the total percentage in each of the four major quality cost categories for the HiTeck Tool Company.

Answer

13. Original Data:Cost Element

Amount

Incoming test and inspection

$ 7,500

Scrap

35,000

Quality training

0

Inspection

24,000

Test

5,000

Adjustment cost of complaints

21,150

Quality audits

2,500

Maintenance of tools and dies

9,200

Quality control administration

5,000

Laboratory testing

1,200

Design of quality assurance equipment

1,200

Material testing and inspection

1,250

Rework

70,000

Quality problem-solving by product engineers

10,000

Inspection equipment calibration

2,500

Writing procedures and instructions

2,500

Laboratory services

2,500

Rework due to vendor faults

17,500

Correcting imperfections

6,250

Setup for test and inspection

10,750

Formal complaints to vendors

10,000

For HiTeck Tool Company, the largest costs are internal failure (56.6%) and appraisal (26.9%). More must be done in quality training, a component of prevention (currently 7.8%), if failure, appraisal, and overall quality costs are to be controlled. External failure costs are 8.6% of quality costs, so screening methods are working fairly well. Note that these proportions are fractions of the total quality costs of $ 245,000.

Quality Cost Categories

Cost Elements

Costs

Subtotal Proportion

APPRAISAL

Incoming test & inspection 7500

Inspection

24000

Test

5000

Laboratory testing

1200

Design of Q.A. equipment*

1200

Material testing & insp. 1250

Insp. equipt. calibration 2500

Formal complaints to vendors* 10000

Setup for test & inspection 10750

Laboratory services

2500

$ 65900 0.269Cost ElementsCosts Subtotal Proportion

PREVENTION

Quality training

0

Quality audits

2500

Maintenance of tools and dies 9200

Quality control admin.

5000

Writing proced. & instr.

2500

$ 19200

0.078

INTERNAL FAILURE COSTS

Scrap

35000

Rework

70000

Correcting imperfections

6250

Rework due to vendor faults 17500

Problem solving - prod. engrs.** 10000

$138750 0.566

EXTERNAL FAILURE COSTS

Adjustment cost of complaints 21150

$ 21150 0.086

Total costs

$247,450

* Note: Any cost traceable to inspection or quality assurance is considered an appraisal cost. This includes Q.A. equipment and the cost of finding and correcting errors with vendors. Q.A. and appraisal dont prevent bad product, they just keep it away from internal or external customers, downstream.

** Problem solving for current problems is an internal failure cost. If a Six Sigma or other team is formed to develop long-term solutions to a quality problem, then it would be classified as a prevention cost.

14. Worldwide Metrology Repairs, Inc. has a thriving business repairing and upgrading high-technology measuring instruments. The costs of quality that they have collected over the past year can be found in the Excel workbook C8Data.xls. Use Pareto analysis to investigate their quality losses and to suggest which areas they should address first in an effort to improve their quality. Answer14. Original Data:

Category

Annual Loss

Customer returns$ 110,000

Inspection costs -- outgoing 35,000

Inspection costs -- incoming 18,000

Workstation downtime 55,000

Training/system improvement 30,000

Rework costs 52,000

Spreadsheet data and the Pareto chart (see spreadsheet Prob8-14.xls for details) for Worldwide Metrology Repairs, Inc. are shown.WORLDWIDE METROLOGY REPAIRS, INC.QUALITY COSTS AND PERCENTAGES

Percent

Cumulative %

Cost

Customer returns

36.67%

36.67%

$110,000

Workstation downtime

18.33%

55.00%

55,000

Rework costs

17.33%

72.33%

52,000

Inspection - out

11.67%

84.00%

35,000

Training/improvement

10.00%

94.00%

30,000

Inspection - in

6.00%

100.00%

18,000

Total Costs

300000

The data show that two categories of customer returns and workstation downtime total 55.0 percent of the defects. These two are possibly related, and may indicate short staffing, and lack of training of setup personnel. Only 10% of total quality cost is allocated to prevention (training/improvement). Steps should be taken to analyze root causes for these problem areas in order to correct them as quickly as possible.

15.Use Pareto analysis to investigate the quality losses at Beechcom Software Corp. using the data in the Excel workbook C8Data.xls. What conclusions do you reach? Answer15. Original Data:Category

Annual Loss

Rework costs

$175,000

Rejected disks (loaded)

30,000

Rejected disks (blank)

18,000

Inspection costs (extra)--incoming

136,000

Inspection costs (extra)--outgoing

65,000

Customer returns

360,000

Training and system improvement costs 28,000

System downtime

88,000

The data for Beechcom Software Corporation show that the three categories of returns, rework, and incoming inspection account for 74.56 percent of the defects. These appear to be completely under the control of the firm, so steps should be taken to analyze root causes for these problem areas in order to correct them as quickly as possible. (See spreadsheet Prob8-15.xls for more details).BEECHCOM SOFTWARE CORPORATION

QUALITY COSTS AND PERCENTAGES

PercentCumulative %Cost

Returns 40.00%40.00%360,000

Rework 19.44%59.44%175,000

Insp. - In.15.11%74.56%136,000

Sys. Downtime 9.78%84.33%88,000

Insp. - Out7.22%91.56%65,000

Rej. disks (load.) 3.33%94.89%30,000

Trng./sys. improve. 3.11%98.00%28,000

Rej.disks (blank) 2.00%100.00%18,000

Total Costs$900,000

16. The Hausburg Company has collected information about customer behavior and lost sales as a result of service problems. They estimate that, given the current level of service and historical data on complaints, the company will lose a total of 900,000 sales from customers who experience problems over a five-year period.

a. At an average of $20 profit per sale, what is the average lost profit per year?

b. Suppose the company can reduce its annual number of lost sales by 10 percent by investing $300,000 to enhance its service through training and better technology. How much profit can be earned as a result? What is the return on this quality investment?

Answer16. Because nothing is mentioned here about the Hausburg Company using a discounted present value, simplified calculating methods, not considering the time value of the money invested, are used in the following solutions:

a) Lost profits = ($20/sale X 900,000) / 5 = $3,600,000 per year

b) Recovered profits = .10 X $3,600,000 = $360,000

So, return on quality for each year is $360,000 / $300,000 = 1.20 or 120% return. This result means that the investment will pay for itself in approximately 10 months of savings, each year.

17. Excelsior Inn, a medium-sized hotel (approximately 450 rooms) has gathered a considerable amount of data and is trying to estimate its return on quality. The site manager is interested in determining what the return would be if she invested in additional service. She has evidence that additional effort in making sure that rooms (in particular, the bathroom) are clean will result in increases in market share, which can easily be translated into dollars of profit. In the table, found in the Excel workbook C8Data.xls, are data taken from a pilot study where various amounts of additional labor, above the present standard, were applied to room cleaning. These have been expressed in annual dollar amounts, based on wages and fringe benefits of current employees servicing the rooms. Customers who stayed in those rooms were then surveyed to determine their levels of satisfaction/dissatisfaction. Percentages of dissatisfied customers have been matched with the annual dollars of improvement efforts from the study.

a. Using linear regression (for example, the Data Analysis tool or Add Trendline option in Excel), determine the equation that can be used to estimate the reduction in customer dissatisfaction, based on additional cleaning effort. What would be the appropriate level of effort to apply, based on your calculations?

b. If each point of market share increase brings in approximately $600,000 of profit per year, and the cost per year is your suggested investment in improvement (from part a above), what would be the return on quality (improvement), based on a three year discounted cash flow at 10 percent of the investment costs, if the site manager estimated that she could realize a 2.5 percent increase in market share?

Answer17. Original Data:

Excelsior Inn -Return on Quality

Service Improvement

Investment (in thousands of dollars)Percent of Customers

- Dissatisfied

00.200

500.150

1500.100

2600.076

2900.067

3000.059

4500.052

6000.045

7500.040

9000.035

10500.031

12000.027

13500.024

15000.021

16500.017

18000.014

19500.010

21000.007

Note to instructors: This is a problem that could challenge even advanced students. It could also be expanded into a case study. The concepts were adapted from the Rust, et al. article, footnoted, here. You may wish to pass this reference on to the students for their use in analysis. The data has been fabricated, instead of using that from the article, so that further computations could be made.

Students would typically calculate the linear regression equation, given below, based on the data given in the problem. Note that fitting a curvilinear model would provide a higher R-squared value. This would require more mathematical sophistication than the average undergraduate business student would typically possess, however. There is no cut and dried answer to what level of additional quality improvement effort would be best, of course. A number of what if questions and scenarios could be raised. Some of these might include:1. What if the sample of hotel guests was not representative of the general population of guests?

2. What if the site manager was simply interested in reducing, rather than eliminating dissatisfied customers?

3. What if her objective was to eliminate the competition, then go back to the previous level of quality?

4. What are the disadvantages of fitting a linear model to the data? (Note: In using Excel 4.0 when this solution was developed, it appears that there is a bug in the module that calculates the equation for the graph. Therefore, the add-in Excel model was used to get the equation and the R-squared value, below.) See spreadsheet Prob8-15 for further details.

Excelsior Inn - Return on Quality

Svc. Improvemt. Effort - $ 000Percent of Customers - DissatisfiedPredicted Y - Regression Line

00.2000.1075

500.1500.1046

1500.1000.0987

2600.0760.0922

2900.0670.0905

3000.0590.0899

4500.0520.0811

6000.0450.0723

7500.0400.0635

9000.0350.0547

10500.0310.0459

12000.0270.0371

13500.0240.0283

15000.0210.0195

16500.0170.0107

18000.0140.0019

19500.010-0.0070

21000.007-0.0158

PARTIAL SUMMARY OUTPUT

Excel Regression Analysis

Regression Statistics

Multiple R0.795781742

R Square0.633268581

Adjusted R Square0.610347868

Standard Error0.031875396

Observations18

Coefficients

Intercept0.107507099

X Variable 1-5.87234E-05

Equation: y = 0.10751 - .0000587 x i

Assume that we use the calculated value of y = 0 (no dissatisfied customers). The model tells us that we will have:

0 = 0.10751 - 0.0000587 x i

So x i = 0.10751 / 0.0000587 = $1831.5 thousand

We can calculate the net present value, using standard present value table figures of:

YearPV Factor for 10%CostPresent Value ($000)

10.9091831.51664.83

20.8261831.51512.82

30.7511831.51375.46

Total Net Present Value4553.11

The return on quality of: ROQ = Annual profit increase/ discounted present value of investment

ROQ = (2.5 points - market share increase x $600) / 4553.11 = 32.9%, which is a very

healthy return on investment

PROJECTS. ETC.

1. Answers will vary, depending on the experience and interests of the students. For example, an airline might measure revenue passenger miles and market share at the organizational level, hours between failures for various mechanical components (such as radios and radar units), hours of flying time for flight crew members, number of delayed or canceled flights in flight operations.

2. The answers will vary here, depending on students' choice of restaurants from which they gather data. Note that many of the internal performance characteristics that relate to the pizza restaurant example in the body of the chapter would also apply to other restaurants, regardless of type.

3. This field exercise is designed to further student awareness of the breadth of the "quality management" and to help them to confirm that key factors from the theory of quality are being applied in practical settings in business and industry.

4. This field exercise is designed to further student awareness of the breadth of the "quality management" and to help them to confirm that leading practices from the theory of quality are being applied in practical settings in business and industry.

5. This diagram may be as simple or as complex as students care to make it. For example it might be hypothesized that a leading indicator of decreased customer satisfaction and loyalty might be complaints, while a lagging indicator would be losses of customers. In the financial and market area, a leading indicator would be increases in sales, while the lagging indicator would be increases in market share. In human resources, absenteeism might be a leading indicator of turnover and decreased employee satisfaction. In the supplier/partner area, quality and delivery would possibly lead to increased costs (the lagging indicator), and in organizational effectiveness, defects and errors would lead productivity declines.

6. This field exercise is designed to further student awareness of the breadth of the "quality management" and to help them to confirm that the cost of quality factors from theory of quality are being applied in practical settings in business and industry.

7. Spreadsheet programs can be used to develop the database, compute the indices, print reports of quality costs in a tabular and graphical form, and calculate "what-if" cases for management decision-making purposes.

8. This field exercise is designed to further student awareness of the breadth of the "quality management" and to help them to confirm that the Six Sigma approaches from the theory of quality are being applied in practical settings in business and industry.

ANSWERS TO CASE QUESTIONSSkyhigh AirlinesThe solution to this case involves a fairly straight-forward sequential analysis of the system that can be obtained by using the following model (note each X = 1 person hour, and the fractions are additional fractions of person-hours required to complete the task, once it has been started):

A -------------- B -------- C ---------- D ------------- E (Tasks) Elapsed TimeProductive Time Person-hours

Working Mechanics

Mech. 1X 2/3 X X XX

X

7.67

Mech. 2X 2/3 X X XX X

Mech. 3X 2/3 X X

X

Mech. 4

X X

X

Mech. 5

X

Idle Mechanics

Mech. 3 -

- 0 XX -Mech. 4 X 2/3

- - XX

-Mech. 5 X 2/3 X -

XX X

Fraction of productive hrs

5/8.33=5/6.25= 5/5=

5/12.5=5/6.25

60%

80% 100% 40%

80% ( 15.36% RTY

60%

80% 100% 100%

80% ( 38.4% RTY-

Revised

[Note: RTY is the pro