By

Geetika 7
&
Kartik Goel 8
 the costs of poor quality

 the costs to attain quality

 the costs of running the Quality department

 1. Quantify the size of the quality problem in language that will
have an impact on upper management.

 2. Identify major opportunities for reduction in cost of poor

quality throughout all activities in an organization.

 3. Identify opportunities for reducing customer dissatisfaction

and associated threats to sales revenues.

 4. Align quality goals with organization goals.

 Internal Failure Costs:
 Failure to Meet Customer Requirements and Needs.
 Cost of Inefficient Processes.

 External Failure Costs: These are costs associated with

deficiencies that are found after product is received by the customer
 Failure to Meet Customer Requirements and Needs.
 Lost Opportunities for Sales Revenue.

 Appraisal Costs: These are the costs incurred to determine the

degree of conformance to quality requirements.

 Prevention Costs: These are costs incurred to keep failure and

appraisal costs to a minimum.
 Hidden Costs: The cost of poor quality may be undervalued
because of costs which are difficult to estimate. These costs occur
in both manufacturing and service industries and include:
 1. Potential lost sales

 2. Costs of redesign of products due to poor quality.

 3. Costs of changing processes due to inability to meet quality

requirements for products.
 4. Costs of software changes due to quality reasons.

 5. Costs of downtime of equipment and systems including

computer information systems.
 6. Extra indirect costs due to defects and errors.

 7. Scrap and errors not reported.

 8. Extra process costs due to excessive product variability

 9. Cost of errors made in support operations

 10. Cost of poor quality within a supplier’s company.

 1. Quality costing approach: This is the failure, appraisal,
and prevention approach.

 2. Process cost approach: The focus is to reduce both the

cost of conformity and the cost of nonconformity. The cost of
conformity this is the cost incurred when a process is running
without failure, i.e., material, labour, and overhead including
prevention and process control activities. The cost of nonconformity
is the traditional cost of internal and external failures.

 3. Quality loss approach: Conceptually it tries to collect

data on many of the “hidden” costs such as loss of sales revenue
due to poor quality, process inefficiencies, and losses when a
quality characteristic deviates from a target value even though it is
within specification limits.
 1. Review the literature on quality costs.

 2. Select one organizational unit of the company to serve as a

pilot site.

 3. Discuss the objectives of the study with the key people in

the organization, particularly those in the accounting function.
Two objectives are paramount:
a. Determine the size of the quality problem and
b. Identify specific projects for improvement.

 4. Collect whatever cost data are conveniently available from

the accounting system and use this information to gain
management support to make a full cost study.
 5. Make a proposal to management for a full study.
The proposal should provide for a task force of all concerned parties
to identify the work activities that contribute to the cost of poor
quality.
 6. Publish a draft of the categories defining the cost of poor
quality. Secure comments and revise.
 7. Finalize the definitions and secure management approval.
 8. Secure agreement on responsibility for data collection and
report preparation.
 9. Collect and summarize the data. Ideally, this should be done
by Accounting.
 10. Present the cost results to management along with the
results of a demonstration quality improvement project.
 The allocation of overhead has a significant impact on calculating
the total cost of poor quality and also on determining the distribution
of the total over the various departments.

 Earlier, manufacturing overhead costs were allocated to functional

departments and to products based on direct labour hours.
Three approaches are used in practice:
 Include total overhead using direct labour hours.
 Include variable overhead only , eg. Machine setup, shipment
etc.
 Or do not include overhead at all
Activity based costing is an accounting method that improves
cost effectiveness through a focus on key cost elements called
cost drivers (measureable activities that increases overhead
costs ).
ABC refines the way product costs are determined by using
computer technology to economically track overhead costs in
smaller categories with many cost drivers such as machine
setups, purchase orders, shipments etc
• Improvement requires an investment of resources, and the
investment must be justified by the blossoming benefits of
improvement.

• The comparison of benefits to investment is called the “return on

quality”(ROQ).

• Some of the issues involved in estimating the benefits are:

a. Reduced cost of errors: Expected savings must be based on
specific plans for improvement with the problem areas for
improvement been explicitly identified and an action plan with
resources been developed.
From Applying Cost of To reduce cost
current Quality & improve
environmen & process quality
t iamprovement

Cost of
b. Improved process capability: Expected savings can come
from a reduction in variability (of product characteristics or process
characteristics) and other process losses such as redundant
operations, sorting inspections, retrieving missing information etc.

c. Reduced customer defections: Progress should be made in

quantifying the benefits of an effort to reduce defections. The
parameters include the economic effect of losing customers over
the “customer life,” the level of quality to retain present customers
and the effect on retention of the quality of handling customer
complaints.
 d. Increase in new customers: Quality improvements that make
goods or services attractive to new customers will increase sales
revenue. without increasing the price, like diagnosis and other
forms of analysis, training, redesign of products and processes,
testing and experimentation, and equipment.

• The rate of return on an investment in quality activities translates

into the ratio of average annual benefits to the initial investment.
 To achieve a significant and lasting reduction in defects and costs
requires a structured process for attacking the main sources of loss
—the failure costs. Such an attack requires proceeding on a
project-by-project basis.

To gain approval from upper management for a quality improvement

effort, we recommend the following steps:

1. Establish that the costs are large enough to justify

action:
• a. Use the grand total to demonstrate the need for quality
improvement.This is the most significant figure in a quality cost
study.
b. Relate the grand total to business measures:
Interpretation of the total is aided by relating total quality costs to
other figures with which managers are familiar. Two universal
languages are spoken in the company.
At the “bottom,” the language is that of objects and deeds: square
meters of floor space, output of 400 tons per week, rejection rates
of 3.6 percent,
At the “top,” the language is that of money: sales,profit, taxes,
investment.
c. Show the subtotals for the broad major groupings of quality
costs, when these are available:
Typically, most of the quality costs are associated with failures,
internal and external. The proper sequence is to reduce the failure
costs first, not to start by reducing inspection costs. Then as the
defect levels come down, we can follow through and cut the
inspection costs as well.
2. Estimate the savings and other benefits:

a. Don’t imply that the quality costs can be reduced to zero.

b. For any benefits that cannot be quantified as part of the return on
quality, present these benefits as intangible factors to help justify the
improvement program. Sometimes, benefits can be related to
problems of high priority to upper management such as meeting
delivery schedules, controlling capital expenditures, or reducing a
delivery backlog.

3. Calculate the return on investment resulting from

improvement in quality:
Where possible, this return should reflect savings in the traditional
cost of poor quality, savings in process capability improvement, and
increases in sales revenue due to a reduction in customer defections
and increases in new customers.
• 4. Use a successful case history of quality
improvement in the company to justify a broader
program.

• 5. Identify the initial specific improvement projects.

• 6. Propose the structure of the improvement

program including organization, problem selection,
training, review of progress, and schedule.
 Roles to Support Improvement:

• 1. Identify the most significant losses for an individual

problem and the specific costs to be eliminated.This
helps to focus the diagnostic effort on root causes.

• 2. Provide a measure of effectiveness of the remedies

instituted on a specific project. Thus, a project quality
improvement team should provide for measuring the costs to
confirm that the remedies have worked.
• 3. Provide a periodic report on specific quality costs. Such a
report might be issued quarterly or semI-annually.

• 4. Repeat the full cost of poor quality study. This study could
be conducted annually to assess overall status and help to
identify future projects.

• 5. Identify future improvement projects by analyzing the full

study (see item 4 above) using Pareto analysis and other
techniques for problem selection.
• Reporting on the cost of poor quality focuses on supporting
structured quality improvement teams.

• These reports provide information which helps to diagnose the

problem and to track the change in costs as a remedy is
implemented to solve the problem.

• These reports provide information which helps to diagnose the

problem and to track the change in costs as a remedy is
implemented to solve the problem.

• After finalizing the categories for a cost scoreboard, the planning

must include collecting and summarizing the data, establishing
bases for comparison, and reporting the results.
• Summarizing the Data :

• The most basic ways are

• 1. By product, process, component, defect type, or other

likely defect concentration pattern

• 2. By organizational unit

• 3. By category cost of poor quality

• 4. By time
BASE ADVANTAGES DISADVANTAGES
Direct labor hour Readily available and Can be drastically
understood influenced by automation

Direct labor dollars Available and understood; Can be drastically

tends to balance any influenced by automation
inflation effect

Standard manufacturing More stability than above Includes overhead costs

Cost dollars both fixed and variable
Value-added dollars Useful when processing Not useful for comparing
costs Not useful for different types of
comparing different types manufacturing
of departments
are important
Sales dollars Appeals to higher Sales dollars can be
management influenced by changes in
prices,marketing costs,
demand, etc.
Product units Simplicity Not appropriate when
different products are
made
• The specific matters are the same as for those for other reports—
format, frequency, distribution, responsibility for publication.

• The likely trend is for cost of poor quality and other quality-related
information to become integrated into the overall performance
reporting system of organizations. Kaplan and Norton
(1996)propose that such a system provide a “balanced scorecard”
allowing managers to view an organization from four perspectives:

• 1. How do customers see us? (Customer perspective.)

• 2. What must we excel at? (Internal perspective.)

• 3. Can we continue to improve and create value? (Innovation

and learning perspective.)

• 4. How do we look to shareholders? (Financial perspective.)

 The costs of poor quality affect two parties—the provider of
the goods or service and the user. Poor quality also
increases the costs of the user of the product in the form of
repair costs after the warranty period, various losses due to
downtime, etc.

 This section stresses the potentialfor profit improvement

by reducing provider costs and by reducing loss of sales
revenue due to poor quality.
• Juran’s Quality Handbook

• Costs of poor quality-concepts and applications- Rajmanohar

▪ Thank you