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TOTAL QUALITY MANAGEMENT

COST OF QUALITY

Dr. Hatice Camgoz Akdag

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Definition• COQ offers managers a financial method to

evaluate the level of their quality and the costs associated with different levels of quality.

• The cost is a well-organized and often disputed tool used to understand the economic consequences of quality.

• Purchasing manager and clever customers are asking: “what are the costs related to quality?”

• The definition of COQ varies but, in general, is considered to be the costs (tangible &intangible) relating to be the quality characteristics of a product or service.

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Difficulties in Capturing the “True Costs”Placing a cost figure on quality is difficult and that

accounting is unable to capture the “true” costs of quality. Some concerns:

• Quality costs do not readily appear in the accounting journals.

• Large timing delays between quality costs and benefits create distortions.

• Accounting rules (product & period costs) do not lend themselves to measuring quality.

• Numerous cost estimates are needed.• There are hidden costs never captured.• Matching future costs with historical costs is

necessary.

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The Traditional Cost-of-Quality Model

The model states that cost can be divided into two broad categories:

1. Conformance Costs

a. Prevention costs

b. Appraisal costs

2. Non-Conformance Costs

a. Internal failure costs

b. External failure costs

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Conformance CostsA. Prevention costs:• Costs associated with all activities designed to

prevent defects in product or service. These include :

• The direct and indirect costs related to quality training and education, pilot studies, quality circles, quality engineering, etc.

• These costs are used to build awareness of the quality program and to keep the costs of appraisal and failure to a minimum.

• Prevention costs are all costs incurred in an effort to “make it right the first time”.

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Types of Prevention Costs1. Quality planning and engineering: creation of the

overall quality plan, the inspection plan, the reliability plan, the data system, all activities of the quality assurance function, the preparation of manuals and procedures used to communicate the quality plan, costs auditing the system.

2. New products review: evaluation of new designs, preparation of tests & experimental programs to evaluate the performance of new products.

3. Product & process design: costs incurred during the design of the product or the selection of the production processes that are intended to improve the overall quality of the product.

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Types of Prevention Costs cont.4. Process control: the cost of process control

techniques, such as control charts, that monitor the manufacturing process in an effort to reduce variation and build quality into the product.

5. Burn-in: the cost of pre-shipment operation of the product to prevent early failures in the field.

6. Training: the cost of developing, preparing, implementing, operating, and maintaining formal training programs for quality.

7. Quality data acquisition and analysis: the cost of running the quality data system to acquire data on product and process performance. Includes cost of analyzing these data to identify quality problems.

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Conformance CostsB. Appraisal costs• The costs associated with measuring and

evaluating the product or service quality to ensure conformance.

• These include the cost of inspection, test or audit of purchases, manufacturing or process operations and finished goods or services.

• The direct and indirect costs of the various tests & inspections to determine the degree of conformity are included in this category.

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Types of Appraisal Costs1. Inspection & test of incoming material:

Costs associated with the inspection and testing of all vendor-supplied material.

• Receiving inspection & test• The same at the vendor’s facility• Periodic audit of the vendor’s quality assurance

system.2. Product inspection & test:

the cost of checking the conformance of the product throughout its various stages of manufacturing.

• Final acceptance testing• Packing and shipping checks• Salaries of inspectors and supervisors.

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Types of Appraisal Costs cont.

3. Materials & Services consumed:

The cost of operating a system that keeps the measuring instruments and equipment in calibration.

4. Maintaining accuracy of test equipment:

the cost of operating a system that keeps the measuring instruments and equipment in calibration.

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Non-Conformance CostsThese are associated with products or services that do not conform the customer's requirement. They are often referred to as “failure” costs and consist of two types.

A. Internal failure costs: • costs incurred prior to the shipment of the product

or the delivery of the service.• These costs are associated with defects that are

found prior to customer delivery.• These include the net cost of scrap, re-inspection

and retest, downtime due to quality problems, opportunity cost of product classified as seconds, or other product downgrades.

• These costs would disappear if there were no defects in the product.

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Types of Internal Failure Costs1. Scrap costs: the net loss of labor, material and

overhead (fixed costs) resulting from defective product that can not economically be repaired or used.

2. Rework: the cost of correcting nonconforming units so that they meet specifications. Rework costs usually include additional operations or steps in the manufacturing process, thus includes extra direct labor, machine time and supplies costs.

3. Retest Cost: the cost of reinspection and retesting of products that have undergone rework or other modification.

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Types of Internal Failure Costs cont.4. Downtime costs: the cost of idle production

facilities that result from nonconformance to requirements.

5. Downgrading cost: the price differential between the normal selling price and any selling price that might be obtained for a product that does not meet the customer’s requirements. Downgrading is common in the textile, apparel goods, electronics, and carpet industries.

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B. External Failure Costs• The costs of discovered defects occurring after

product shipment or service delivery. • These costs include warranty charges, customer

complaint adjustments, returned merchandise, product recalls, allowances, and product liability.

• They also include the direct and indirect costs such as labor and travel associated with the investigation of customer complaints, warranty field inspection, tests and repairs.

• These costs would disappear if every unit of product conformed to requirements and specifications.

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Types of External Failure Costs1. Complaint adjustment: all cost of investigation and

adjustment of justified complaints attribute to the nonconforming product.

2. Returned product & material: all costs associated with receipt, handling, and replacement of the nonconforming product or material returned from the field. Also recalls of defective product.

3. Warranty charges: all costs involved in service to customers under warranty contracts. Includes repair and replacement of product or parts.

4. Liability costs: costs or awards incurred as a result of product liability litigation.

5. Indirect costs: in addition to direct operating costs of external failures, there are some indirect costs.

• Customer dissatisfaction with the level of quality• Loss of good-will; loss of business reputation; loss of future

business; loss of market share.

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Cost of Quality =

Cost of Prevention+Cost of Appraisal

+Cost of Failure

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Reducing the Cost of Quality• The aim of management is to minimize the cost of

quality.• It makes no difference if this is done by reducing

all three components or by increasing some and decreasing others enough to lower the total cost.

• To have a significant impact on the total cost; the cost of failure must be reduced, and the usual strategy for achieving this objective is to spend more on prevention.

• “It is always cheaper to do a job right the first time than to do it over”.

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The Traditional Cost of Quality Model

• The study of the relationship of the COQ categories led to the development of a significant body of economic literature offering various models to explain the interrelationship of the COQ categories.

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The Original or Classical COQ model

Cost per good unit of

product

Quality of conformance %

Total quality costs

Failure costs

Costs of appraisal plus prevention

1000

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Definition of COQ model figure• In this case, the costs of prevention and appraisal are zero with a

100% failure rate. • The costs of prevention & appraisal rise to infinity as perfection

(no failures) is reached.• This hypothetical model shows that total quality cost is higher

when quality is low and falls as quality improves.• According to the model, a company greatly reduce failure costs

by adding relatively low-cost prevention and appraisal measures.

• As prevention and appraisal expenditures continue to rise, the rate of improvement begins to diminish until additional expenditures produce little decrease in failure.

• The model suggests that a relationship exists between conformance and nonconformance quality costs, with a minimal total quality cost at the optimal balance.

• Implicit in this model is the trade off of conformance costs for nonconformance costs to achieve the lowest total quality cost.

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Behavior of Cost Components During TQM Implementation

The general behavior of the four quality cost components for a company starting TQM is as follows:

• Prevention costs remain relatively consistent as the awareness of TQM is built and maintained.

• Appraisal costs will initially increase as inspection programs are initiated but should eventually level off.

• Internal failure costs will initially increase as the inspection programs are implemented, but should the gradually decrease with learning.

• External failure costs should continue to fall as various TQM programs are brought on line.