Total Quality Management

Week # 7

Cost of Quality Prepared by: Khalid Dahleez Faculty of Commerce the Islamic University of Gaza
This material was collected from different sources

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Understand Quality Costs

Understand quality costs enables you to Understand hidden costs Reduce and eliminate unnecessary cost Prevent problems from happening Management responsibility to enable this Quality costs are real and estimated at: 25% of costs in manufacturing 35% of costs in service industry Quality costs can be categorised to enable better understanding

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Why calculate Quality Cost

Management will give special attention when quality is measured in monetary terms Quality costing is one of the tools to provide initial assessments and hard evidence that improvement is needed or had been made To monitor the effectiveness of quality improvement initiatives To be used in a generic term by senior management, shareholders and financial institutions, so that they can readily understand implication of quality in the term of money Cost of quality failure is calculated as a percentage of profit or annual turnover It is easy to understand

By front-line operator By middle management

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Benefits of using quality costing

Greater accuracy in the evaluation and forecasting of resource use Justification for investment in the prevention and appraisal of failures Ability to cost and compare performance across all departments functions and activities Identification and prioritization of activities, processes and departments in terms of corrective action, investment, or quality improvement initiatives

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Benefits of using quality costing (2)

Ability to set cost-reduction targets and then to measure and report progress Ability to produce local data which improves understanding of resource utilization objectives and targets at all levels throughout the company Provision of data to support formal quality management system (including, especially; those based upon the ISO9000) Enable decisions about quality to be made in an objective and systematic manner Promoting TQM and a company-wide quality improvement culture

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COST OF QUALITY

Quality costs are defined as costs associated with non-achievement of product/service quality. In simple terms, quality cost is the cost of poor products/services. The cost of poor quality can add to other costs such as design, production, maintenance, inspection, sales, etc. Quality costs cross department boundaries by involving all activities of the organization marketing, purchasing, design, manufacturing, service, etc. The price of nonconformance (Philip Crosby) or the cost of poor quality (Joseph Juran), the term 'Cost of Quality', refers to theTotal Quality Management - Spring 2010 costs associated with providing poor quality product or service. IUG

Founders Point of View

Phillip B. Crosby (Quality is free . . . ):
The system for causing quality is prevention, not appraisal Quality is Free The performance standard must be Zero Defects, not "that's close enough" The measurement of quality is the Price of Nonconformance. Cost of quality is only the measure of operational performance Quality is free. Its not a gift, but it is free. What costs money are the unquality things -- all the actions that involve not doing jobs right the first time.
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Total Quality Management (TQM)

Customers will seek out the highest quality product. Improved quality that exceeds customer expectations will generate more revenues that exceed the cost of quality.

Therefore, quality is free.

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Total Quality Management (TQM)

W. Edwards Deming proposed that improving quality reduces cost and improves profitability. Quality can be and should be improved continuously.

Revenues
Total Revenues & Costs

Max Profit Cost

Max Quality

Quality

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Return on Quality (ROQ)

Profit is maximized at the optimum quality level. The optimum quality level is always achieved before maximum attainable profit is reached.

Cost
Total Revenues & Costs

Revenues Max Profit

Optimum Quality

Quality

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Founders Point of View

Feigenbaum (Originator of Total Quality

concept)
Definition of Quality costs (1956)
Appraisal costs Prevention costs Failure costs

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Cost of Quality

Cost of Achieving Good Quality

Prevention costs
costs incurred during product design

Appraisal costs
costs of measuring, testing, and analyzing

Cost of Poor Quality

Internal failure costs
include scrap, rework, process failure, downtime, and price reductions

External failure costs

include complaints, returns, warranty claims, liability, and lost sales
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Prevention Costs

Quality planning costs

costs of developing and implementing quality management program

Training costs
costs of developing and putting on quality training programs for employees and management

Product-design costs
costs of designing products with quality characteristics

Information costs
costs of acquiring and maintaining data related to quality, and development of reports on quality performance

Process costs
costs expended to make sure productive process conforms to quality specifications

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Examples of prevention Cost

Application screening Capability studies Controlled storage Design review Equipment maintenance & repair Field testing Fixture design and fabrication Forecasting Housekeeping Job descriptions Market analysis Pilot projects Procedure writing Prototype testing Procedure reviews Quality incentives Safety reviews Time and motion studies Survey Quality training salesperson evaluation and selection Personnel reviews
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Appraisal Costs

Inspection and testing

costs of testing and inspecting materials, parts, and product at various stages and at the end of a process

Test equipment costs

costs of maintaining equipment used in testing quality characteristics of products

Operator costs
costs of time spent by operators to gather data for testing product quality, to make equipment adjustments to maintain quality, and to stop work to assess quality

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Examples of appraisal cost

Audit Document checking Diagram checking Equipment calibration Final inspection In-process inspection

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

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Internal Failure Costs

Scrap costs
costs of poor-quality products that must be discarded, including labor, material, and indirect costs

Process downtime costs

costs of shutting down productive process to fix problem

Rework costs
costs of fixing defective products to conform to quality specifications

Price-downgrading costs
costs of discounting poor-quality products that is, selling products as seconds

Process failure costs

costs of determining why production process is producing poor-quality products

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External Failure Costs

Customer complaint costs

costs of investigating and satisfactorily responding to a customer complaint resulting from a poor-quality product

Product liability costs

litigation costs resulting from product liability and customer injury

Product return costs

costs of handling and replacing poor-quality products returned by customer

Lost sales costs

costs incurred because customers are dissatisfied with poor quality products and do not make additional purchases

Warranty claims costs

costs of complying with product warranties

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Defects, Scrap, Rework, Inspection, Returns, Warranty, Quality Assurance

Prevention
Design Review, Zero Defects Program, Supplier Training, Supplier Evaluation, Specification Review, Quality Audits, Preventive Maintenance, Engineering Changes, Product Liability, Increased Overhead

Appraisal
Vendor Surveillance, Receiving Inspection, Product Acceptance, Process Control, Inspection Labor, Quality Control Labor, Testing Equipment Costs

Internal Failure
Downtime, Engineering Changes, Excess Inventory, Disposal Costs, Reinsertion

External Failure
Consumer Affairs, Purchase Changes, Service after Sales, Product Liability, Lost Market Share Delivery Delay

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Classifying Quality Costs

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Preventing Poor Quality (Comparison)

Prevention Costs

Appraisal Costs

Benefit

Repair Costs

Prevention Costs

Failure Costs Internal External

Appraisal Costs Repair Costs Failure Costs

Before Quality Cost Alignment

After Quality Cost Alignment

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Cost of Quality (other version)

1. Like all things there is a price to pay for quality. This total cost can be split into two fundamental areas: a. Non Conformance. This area covers the price paid by not having quality systems or a quality product. Examples of this are:
(1) Rework. Doing the job over again because it wasn't right the first time. (2) Scrap. Throwing away the results of your work because it is not up to the required standard. (3) Waiting. Time wasted whilst waiting for other people. (4) Down Time. Not being able to do your job because a machine is broken.

b. Conformance. Conformance is an aim of quality assurance. This aim is achieved at a price. Examples of this are:
(1) Documentation. Writing work instructions, technical instructions and producing paperwork. (2) Training. On the job training, quality training, etc. (3) Auditing. Internal, external and extrinsic. (4) Planning. Prevention, do the right thing first time and poka yoke. (5) Inspection. Vehicles, equipment, buildings and people.
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Cost of Quality (other version)

2. These two main areas can be split further as shown below: FIGURE 1.3

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1-10-100 Rule
1 $ $ $ $ $ 10 100

Prevention Correction $ $

Failure

$
$ $

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The 1:10:100 rule:

Re.1 spent on prevention will save Rs.10 spent on appraisal and Rs.100 on failure costs.
One dollar spent on prevention will save $10 on appraisal and $100 on failure costs. This rule helps one to prioritize expenditure on prevention, which is sure to bring in greater returns. The earlier you detect and prevent a defect the more you can save. If you catch a two cent resistor before you use it and throw it away, you lose two Cents. If you dont find it until it has been soldered into a computer component, it may cost $10 to repair the part. If you dont catch the component until it is in the computer users hands, the repair will cost hundreds of dollars. Indeed, if a $5000 computer has to be repaired in the field, the expense may exceed the manufacturing cost.
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Difficulties in using Quality costing

Management have not believed in the possibilities of improvement Quality costing is demanding It requires a lot of data of each activity related to quality Other limitations Does not resolve quality problems Does not provide specific actions vulnerable to short-term mismanagement difficult to match effort and accomplishment subject to measurement errors may neglect important or include inappropriate costs

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Steps in implementing quality cost

1. 2. 3. 4. 5. 6. 7. 8. 9.

Involve accountants right from the start Decide purpose and objectives Decide how to deal with overheads Distinguish between basic work and quality related activities Collection data which offers the prospect of real gains Start by examining failure costs Evaluate the costs of inspection Analyze and use the data Collecting and reporting quality cost data

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Preventing Poor Quality

Would it not make sense to prevent poor quality products from happening? How can this be done? Whose responsibility is this?

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How to Prevent Poor Quality

Prepare to measure costs of quality Determine categories of quality costs Create measurement system that captures categories of quality costs Assign responsibility to collect data Analyse collected data

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Determine Quality Cost Categories

Understand your product Understand your process Understand where problems occur Determine precisely what goes wrong Determine what costs represents each problem
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Creating Data Collection System

Create measurement system Attempt to harness existing financial accounting system Manipulate existing financial data Collect costs as they occur Whatever you do ensure costs are accurate
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Assign Responsibility
Make individuals at all levels responsible for collecting quality cost data: If quality cost data is required then make it the responsibility of the person who creates the cost to collect the data If no one is responsible no one will bother

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Analyse Collected Data

Data on its own is useless You must have it analysed to be able to extract meaning Determine what knowledge you require Develop an analysis system that provides the knowledge you require

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Useful Quality Cost Knowledge

What you need to know is useful What you do not need to know is useless Only ask for knowledge you need to know Demand that knowledge is presented so that it can be understood easily

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Management is Responsible
Management decides what to produce in terms of Products (goods and / or services) Management assigns responsibilities to produce products Management is accountable for effectively using resources to produce products

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History of Activity-Based Costing

Term activity-based costing created in 1975 by Dr. Robert Kaplan

Resulted from dissatisfaction with traditional accounting categories Identifies activities as the fundamental cost object of an organization Widely used in industries (e.g. FedEx, Texas Instruments)

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Benefits Associated With ABC

More precise cost information Improved cost control and management

Improved insight into cost causation

Better performance measures

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Definitions

Activity Based Costing (ABC) is a methodology that measures the cost and performance of resources, activities and cost objects. Cost objects consume activities, and activities consume resources.

Activity Based Management (ABM) is the broad discipline that focuses on achieving customer value through the continuous management of activities. ABM draws on ABC cost information and performance measurement as a major (but not only) source of information.

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The Link Between Quality and Productivity Effective quality improvement can be
instrumental in increasing productivity and reducing cost.

The cost of achieving quality improvements and increased productivity is often small.

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Summary Slide

The following Slides are for understanding only (subject to indirect Questions): 37, 38, 39, 40

Other slides are required and subjects to any type of Questions

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