CHAPTER-03
Cost of Quality
2B-2
Learning Objective
Identify the four types of
quality costs and explain
how they interact.
Quality of Conformance
A product that meets or exceeds its design specifications and
is free of defects that mar its appearance or degrade its
performance is said to have high quality of conformance .
Note that if an economy car is free of defects, it can have a
quality of conformance that is just as high as a defect-free luxury
car. The purchasers of economy cars cannot expect their cars to
be as opulently equipped as luxury cars, but they can and do
expect them to be free of defects.
2B-3
Quality Cost
Preventing, detecting, and dealing with defects causes costs
that are called quality costs or the cost of quality. The term
quality cost refers to all of the costs that are incurred to
prevent defects or that result from defects in products. Many
companies are working hard to reduce their quality costs.
Quality costs can be broken down into four broad groups. Two of these
groups— known as prevention costs and appraisal costs —are incurred in
an effort to keep defective products from falling into the hands of
customers.
The other two groups of costs—known as internal failure costs and
external failure costs —are incurred because defects occur despite efforts
to prevent them.
Examples of specific costs involved in each of these four groups are given
in Exhibit 2B–1
Prevention Costs
Generally, the most effective way to manage quality costs is to avoid having
defects in the first place.
It is much less costly to prevent a problem from ever happening than it is to
find and correct the problem after it has occurred.
Prevention costs support activities whose purpose is to reduce the number of
defects.
Note from Exhibit 2B–1 that prevention costs include activities relating to
quality circles and statistical process control.
Quality circles consist of small groups of employees that meet on a regular
basis to discuss ways to improve quality. Both management and workers are
included in these circles. Quality circles are widely used and can be found in
manufacturing companies, utilities, health care organizations, banks, and many
other organizations.
Statistical process control is a technique that is used to
detect whether a process is in or out of control.
An out-of-control process results in defective units and may be
caused by a miscalibrated machine or some other factor.
In statistical process control, workers use charts to monitor the
quality of units that pass through their workstations.
With these charts, workers can quickly spot processes that are
out of control and that are creating defects. Problems can be
immediately corrected and further defects prevented rather than
waiting for an inspector to catch the defects later.
Appraisal Costs
Any defective parts and products should be caught as early as possible in
the production process.
Appraisal costs , which are sometimes called inspection costs, are
incurred to identify defective products before the products are shipped to
customers.
Unfortunately, performing appraisal activities doesn’t keep defects from
happening again, and most managers now realize that maintaining an
army of inspectors is a costly (and ineffective) approach to quality
control.
Therefore, employees are increasingly being asked to be responsible for
their own quality control. This approach, along with designing products to
be easy to manufacture properly, allows quality to be built into products
rather than relying on inspection to get the defects out.
Internal Failure Costs
Failure costs are incurred when a product fails to conform to its design
specifications. Failure costs can be either internal or external.
Internal failure costs result from identifying defects before they are
shipped to customers.
These costs include scrap, rejected products, reworking of defective units,
and downtime caused by quality problems.
Of course, the more effective a company’s appraisal activities, the greater
the chance of catching defects internally and the greater the level of
internal failure costs.
This is the price that is paid to avoid incurring external failure costs, which
can be devastating.
External Failure Costs
External failure costs result when a defective product is
delivered to a customer.
As shown in Exhibit 2B–1 , external failure costs include
warranty repairs and replacements, product recalls, liability
arising from legal action against a company, and lost sales
arising from a reputation for poor quality.
Such costs can reduce profits.
In the past, some managers have taken the attitude, “Let’s go
ahead and ship everything to customers, and we’ll take care of
any problems under the warranty.” This attitude generally
results in high external failure costs, customer ill will, and
declining market share and profits.
Distribution of Quality Costs
Quality costs for some companies range between 10% and 20%
of total sales, whereas experts say that these costs should be
more in the 2% to 4% range.
How does a company reduce its total quality cost?
The answer lies in how the quality costs are distributed.
Refer to the graph in Exhibit 2B–2 , which shows total quality
costs as a function of the quality of conformance.
The graph shows that when the
quality of conformance is low, total
quality cost is high and that most of
this cost consists of costs of internal
and external failure.
A low quality of conformance means
that a high percentage of units are
defective and hence the company has
high failure costs.
However, as a company spends more
and more on prevention and
appraisal, the percentage of defective
units drops.
This results in lower internal and
external failure costs. Ordinarily, total
quality cost drops rapidly as the
quality of conformance increases.
Thus, a company can reduce its total
quality cost by focusing its efforts on
prevention and appraisal.
As a company’s quality program becomes more
refined and as its failure costs begin to fall,
prevention activities usually become more
effective than appraisal activities.
Appraisal can only find defects, whereas
prevention can eliminate them. The best way to
prevent defects from happening is to design
processes that reduce the likelihood of defects
and to continually monitor processes using
statistical process control methods.
2B-8
Learning Objective
Prepare and interpret a
quality cost report.
Quality Cost Reports
As an initial step in quality improvement programs, companies
often construct a quality cost report that provides an estimate of
the financial consequences of the company’s current level of
defects.
A quality cost report details the prevention costs, appraisal
costs, and costs of internal and external failures that arise from
the company’s current quality control efforts.
A typical quality cost report is shown in Exhibit 2B–3 .
Quality Cost Reports in Graphic
Form
As a supplement to the quality cost report
shown in Exhibit 2B–3 , companies frequently
prepare quality cost information in graphic
form.
Graphic presentations include pie charts, bar
graphs, trend lines, and so forth. The data for
Ventura Company from Exhibit 2B–3 are
presented in bar graph form in Exhibit 2B–4 .
2B-10
Uses of Quality Cost Information
A quality cost report has several uses.
First, quality cost information helps managers see
the financial significance of defects.
Managers usually are not aware of the magnitude of
their quality costs because these costs cut across
departmental lines and are not normally tracked and
accumulated by the cost system.
Thus, when first presented with a quality cost report,
managers often are surprised by the amount of cost
attributable to poor quality.
Second, quality cost information helps
managers identify the relative importance of the
quality problems faced by their companies.
For example, the quality cost report may show
that scrap is a major quality problem or that the
company is incurring huge warranty costs.
With this information, managers have a better
idea of where to focus their efforts.
Third, quality cost information helps
managers see whether their quality
costs are poorly distributed.
In general, quality costs should be
distributed more toward prevention and
appraisal activities and less toward
failures.
2B-12
Limitations of Quality Cost Information
Simply measuring and reporting
quality cost problems does not
solve quality problems.
Results usually lag behind
quality improvement
programs.
The most important quality cost,
lost sales, is often omitted from
quality cost reports.
International Aspects of
Many Quality
of the tools used in quality management today were
developed in Japan after World War II.
In statistical process control, Japanese companies borrowed
heavily from the work of W. Edwards Deming.
However, Japanese companies are largely responsible for
quality circles, JIT, the idea that quality is everyone’s
responsibility, and the emphasis on prevention rather than on
inspection.
In the 1980s, quality reemerged as a pivotal factor in the
market. Many companies now find that it is impossible to
effectively compete without a very strong quality program in
place. This is particularly true of companies that wish to
compete in the European market.
The ISO 9000 Standards
The International Organization for
Standardization (ISO), based in Geneva,
Switzerland, has established quality control
guidelines known as the ISO 9000 standards .
Many companies and organizations in Europe
will buy only from ISO 9000-certified suppliers.
This means that the suppliers must
demonstrate to a certifying agency that:
1. A quality control system is in use, and the
system clearly defines an expected level of
quality.
2. The system is fully operational and is backed
up with detailed documentation of quality
control procedures.
3. The intended level of quality is being
achieved on a sustained, consistent basis.
2B-14
End of Chapter-02
