Cost of Quality (PDF)

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The business climate is becoming increasingly more competitive. There are multiple options available to the consumer for nearly every product in the market.

Business is required to stay price competitive to survive. The top performing businesses do set themselves apart from the competition by listening to the voice of the customer and providing products that meet the customer's requirements while maintaining a high level of quality and dependability.

These businesses invest in measuring Cost of Quality and use the information gained to their advantage. Remember a commercial that was being shown on television, years ago, that advertised oil filters. The tag line of that advertisement was "Pay Me Now or Pay Me Later". The message conveyed was that preventive maintenance of your vehicle could prevent more costly repairs down the road. Cost of Quality is much the same.

A business can choose to invest in upfront quality costs to reduce or prevent failures or pay in the end when the defect is eventually discovered by the customer. Many business organizations choose the latter because for them the investment towards the concept is a dead amount, which cannot be rotated. But what they forget to understand is that product failures can result in increased warranty costs and possibly even product recalls, which has a severe and devastating impact on the bottom line (operating cost). In addition, there are the hard to measure costs incurred due to loss of brand equity and possible decline in future sales.

Cost of Quality can have an immense impact on a company's bottom line, positive or negative. The choice lies with BUSINESS

What is Cost of Quality (COQ)

Cost of Quality is a methodology used to define and measure where and what amount of a business resources are being consumed for prevention activities and maintaining product quality as opposed to the costs resulting from internal and external failures.

The basic principle is that Cost of Quality (CoQ) is represented by the sum of two factors, primarily The Cost of Good Quality (CoGQ) and The Cost of Poor Quality (CoPQ), as represented in the basic equation below:

CoQ = CoGQ + CoPQ

The Cost of Quality equation, as mentioned above, looks simple but the reality is it is a complex issue.

The Cost of Quality includes all costs associated with the quality of a product from preventive costs intended to reduce or eliminate failures, cost of process controls to maintain quality levels and the costs related to failures both internal and external.

Why Implement Cost of Quality (COQ)

Effective use and implementation of Cost of Quality concept enables an organization to accurately measure and differentiate the amount of resources being used for Cost of Good Quality and Cost of Poor Quality.
With this valuable information a business can determine where to allocate resources to improve product quality and the bottom line.

An example to understand this concept better:

Alpha Company once measured Cost of Quality as the amount of warranty cost versus total sales. The method only examines the Cost of Poor Quality.

Company gathered the data and after the analysis of the data the company reached to a conclusion towards a problem area in the facility.

It was discovered that part shortages originating from one of the process steps were resulting in warranty costs of over $400,000 in one year.

A team was formed to investigate and perform Root Cause Analysis (RCA) of the shortages and a plan was developed to redesign the process step for an estimated cost of $60,000. With management approval, the process step was redesigned with a revised layout, pick bins, dedicated locations for all the parts, process controls were defined and implemented, and several additional improvements were made.

The changes reduced TAKT TIME (available time for producing a product), and the number of operators required for the process. This provided resources for the addition of quality technicians to regularly audit and maintain the process on all shifts. Within the first year of operation, shortages were reduced by 50% resulting in $200,000 reduction in warranty costs.

This project resulted in a positive impact on the bottom line of $140,000 in the first year. Alpha Company, since than took steps towards implementing processes to measure and reduce scrap, improved process controls and introduced new quality metrics throughout the organization.

They are now actively measuring and evaluating both the cost of good quality and poor quality.
In the example above, the Cost of Poor Quality (CoPQ) was having a major impact on the bottom line. Through an investment in the Cost of Good Quality (CoGQ), Alpha Company achieved a significant reduction in the Cost of Quality.

There are ?n' number of opportunities for improvement in the processes in most of the business set-ups. It has been estimated that the Cost of Quality usually amounts to between 15-40% of business costs.

The objective of implementing Cost of Quality methodology is to maximize product quality while minimizing cost. Cost of Quality methodology provides the detailed information that management needs to accurately evaluate the effectiveness of their quality systems, identify problem areas and opportunities for improvement.

How to Measure Cost of Quality (COQ)

There are methods for calculating Cost of Quality vary from Business to business. In many cases, businesses like the one described in the previous example, determine the Cost of Quality by calculating total warranty dollars as a percentage of sales. But this method is only looking externally at the Cost of Quality and not looking internally. To gain a better understanding, a more comprehensive look at all quality costs is required.

The Cost of Quality can be divided into four categories. They include

? Prevention
? Appraisal
? Internal Failure
? External Failure

Within each of the four categories there are numerous possible sources of cost related to good or poor quality. Some examples of typical sources of Cost of Quality are listed below.

The Cost of Good Quality (CoGQ)

1. Prevention Costs ? costs incurred from activities intended to keep failures to a minimum. These can include, but are not limited to:

•  Establishing / standardizing Product Specifications
•  Quality Planning
•  New Product Development and Testing
•  Development of a Quality Management System (QMS)
•  Proper Employee Training

2. Appraisal Costs ? costs incurred to maintain acceptable product quality levels. Appraisal costs can include, but are not limited to:

•  Incoming Material Inspections
•  Process Controls
•  Check Fixtures
•  Quality Audits
•  Supplier Assessments

The Cost of Poor Quality (CoPQ)
3. Internal Failures ? costs associated with defects found before the product or service reaches the customer. Internal Failures may include, but are not limited to:

•  Excessive Scrap
•  Product Re-work
•  Waste due to poorly designed processes
•  Machine breakdown due to improper maintenance
•  Costs associated with failure analysis

4. External Failures ? costs associated with defects found after the customer receives the product or service. External Failures may include, but are not limited to:

•  Service and Repair Costs
•  Warranty Claims
•  Customer Complaints
•  Product or Material Returns
•  Incorrect Sales Orders
•  Incomplete BOMs
•  Shipping Damage due to Inadequate Packaging



These four categories are to be applied to the original Cost of Quality equation.

CoQ = CoGQ + CoPQ

The other way to understand it is:

? The Cost of Good Quality is the sum of Prevention Cost and Appraisal Cost (CoGQ = PC + AC)
? The Cost of Poor Quality is the sum of Internal and External Failure Costs (CoPQ = IFC + EFC)

By combining the equations, Cost of Quality can be more accurately defined, as shown in the equation below:

COQ = (PC + AC) + (IFC + EFC)

Important to note here is that the Cost of Quality equation is nonlinear. Investing in the Cost of Good Quality does not necessarily mean that the overall Cost of Quality will increase. The flip side of aforesaid statement is that when the resources are invested in the right areas, the Cost of Quality decreases. When failures are prevented / detected prior to leaving the facility and reaching the customer, Cost of Poor Quality is reduced.

Source: Best Practices in Quality Management & Assurance PDF: Cost of Quality PDF (PDF) Document, RKG