Management
Management

The Cost of Quality

November 2, 2012
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ledgers accounting receipt tapeLearn why it matters, how to calculate it, and what to do with the results.  
 
It can affect everything from profits, suppliers and manufacturing location. Calculating the cost of quality can help improve quality, save money and reduce outsourcing. However you calculate it, the end result should be lower costs. The idea is to minimize the entire cost of production.
 
 When Quality spoke to Douglas C. Wood recently, he was in the middle of editing the fourth edition of ASQ’s Cost of Quality manual, which should be out later this year. Wood, principal of DC Wood Consulting (Fairway, KS), says the ASQ cost of quality courses have seen more interest recently. He says the language of cost of quality is the biggest change he’s seen over the years. Though he uses the “ancient” term cost of quality, he says, “It’s really about the finance improvement.”
“When you do something correctly the first time, that’s the cost of doing business,” Wood says. “But anytime you have to go back and do something again, that’s the cost of quality.”
 

Cost of Quality Explained

In 1943, Armand Feigenbaum developed a quality costing model.  The Prevention-Appraisal-Failure concept appeared in 1956 with his article in the Harvard Business Review. This model is not the only one, however. Other models exist, such as Activity Based Costing (ABC). 
 
Tech Tips
  • Measuring and tracking the cost of quality can improve decision making.
  • Research has shown that smaller companies that didn’t track cost of quality often had higher costs.
  • Cost of quality measures are one way for businesses to set improvement goals.
Let’s examine the classic cost of quality model and its focus on prevention, appraisal and failure. Prevention costs, as the name applies, are those that aim to prevent or reduce the risk of defects. Appraisal costs come from the evaluation or inspection process. Failure costs, which can be internal or external, result from scrap, rework, or warranty issues. These costs can all be measured—though they do require some calculation—and then companies can aim to eliminate or reduce them. Though some companies track cost of quality, experts say many more could benefit from it. 
 
“I wish I could provide evidence that more organizations are using cost of quality and initiating programs to systematically reduce those costs,” says Victor E. Sower, an author, quality management consultant and distinguished professor emeritus of management at Sam Houston State University. “However, I do not find that evidence.” Sower and his coauthors published their cost of quality research in 2007 in the International Journal of Quality & Reliability Management. In surveying members of the Quality Management Division of ASQ, they found that about one third of organizations systematically tracked cost of quality. “We have seen no evidence since then that this percentage is substantially higher today,” Sower says. 
 
This is a shame, because tracking cost of quality has proven to be a useful tool. 
 
“For those organizations tracking cost of quality, we found that both internal and external failure costs decreased as prevention costs increased and that external failure costs decreased as appraisal costs increased,” Sower says. 
 
In other words, prevention costs can prevent failure costs, and failure costs are the ones that can take down a business, hurting its reputation and relationship with customers. And even if you still have to invest in quality, spending on prevention is always better than spending on the cure.
 
Gary Cokins, founder and CEO of Analytics-Based Performance Management LLC (Cary, NC) and cost management author, notes that “If you do more prevention and appraisal, it may still be the same million dollars. But it’s a better million dollars because it’s internal and not affecting customers.” 
 
But just reducing failure costs is not enough, notes Praveen Gupta, president of Accelper Consulting (Schaumburg, IL). He says that the goal should be to reduce cost of appraisal and failure. To achieve this, just measuring the cost of quality is not enough. “Measurement’s main purpose, including cost of quality, is to drive improvements,” Gupta says.
 

Why Track Cost of Quality? 

As with many other programs, Sower says management support can be the biggest hurdle. But managers will pay attention if asked, “Are you aware that we are spending 20% of sales on quality?” Sower says. This will most likely be greeted with incredulity, followed by “What can we do about it?” The idea is to then present a few potential projects and expected results. But management should also know that implementing a cost of quality study will first raise the cost of quality, as investing in prevention activities may take time to see a return. 
 
“It is better to think of prevention and assessment costs as investments to assure that things are done right,” Sower says. “We should not be averse to increasing our investment in these cost of quality categories. Internal and external failure costs are incurred when things are not done right.”
 
Smaller organizations should especially take note. Sower found that larger organizations tended to have more developed quality systems and better tracking of cost of quality. The smaller companies that didn’t track cost of quality often had higher costs.
 
“On the brighter side,” Sower says, “more organizations are adopting information systems such as ERP and ABC that facilitate the tracking of cost of quality.  As the power of these systems is utilized to track cost of quality, one may expect to see decreases in the cost of quality.”
 
Knowing the cost of quality can improve decision making and it may also factor in to other initiatives, such as ISO. In a Quality article on preparing for ISO registration, Mike Ryer recommends doing a root cause analysis (RCA) to determine the factors influencing cost of quality. Ryer writes, “Not doing RCA is like being really good at putting out fires, but not finding the guy with the matches setting the fires in the first place.”
 
But, as David M. Anderson, consultant with Build-to-Order Consulting and fellow of the American Society of Mechanical Engineers, explains, some efforts to lower costs can actually be counterproductive: “There is usually pressure to reduce ‘cost,’ but if the cost system only quantifies parts and labor, then it will encourage (maybe pressure) the engineers to specify cheap parts, whose ‘savings’ will be more than cancelled out by various costs of quality. Similarly, emphasizing labor cost may encourage offshoring, which is legendary for raising quality costs.” 
 
Harry Moser, founder of the Reshoring Initiative and Quality’s 2012 Professional of the Year, espouses this idea of monitoring the total cost of production, with his Total Cost of Ownership Estimator. (To examine your company’s total costs, visit www.reshorenow.org.)
 

Finding the Cost of Quality

Wood teaches an ASQ cost of quality course and says the first step in tracking cost of quality would be to designate a point person. He also recommends reading up on the topic, taking a class in-house that would involve a cross functional team. The team could then go on to build a program to reduce these quality costs.
Data collection methods vary. It could be a quality engineer with a spreadsheet or companies using Activity Based Costing. Either way, the initial baseline of finding the cost of quality is time-consuming—but also eye-opening. Sower says that the important thing is to track the cost of quality and monitor changes over time. It can be done on a yellow notepad or with more sophisticated software. Even if you don’t have numbers to the last decimal, reasonably accurate estimates will still help, he says.
 
In a report released this June, LNS Research (Cambridge, MA) found that investing in the costs of good quality are more than offset by the reductions in poor quality. In many cases, this investment may involve new tools. Matthew Littlefield, president and principal analyst of LNS Research, cautions that buying new software should not be the first step in tracking cost of quality, but it can help. “One of the trends I’ve seen that’s new in the past year or two is that some of the software companies are embedding cost of quality calculators into solutions,” Littlefield says.
 
But the metric isn’t embraced by everyone. In his twenty-five years of business, Douglas Hicks, a certified public accountant at D. T. Hicks & Co. (Bloomfield Hills, MI), says he has never seen company finance people zealous about the topic. The finance staff or chief operating officers didn’t consider it high on their agenda, Hicks says. “Quality was, but calculating the cost of quality wasn’t,” he says. For some, it isn’t important to track this subset of the business, but rather costs as a whole. 
 
Though the concept has been around for decades, it has evolved. Mariela Koenig, research director, manufacturing at the Aberdeen Group (Boston), has noticed some differences over the years. “Quality is becoming early in the process, companywide, and the tack on cost of quality has shifted,” Koenig says, “from how much money we are spending to how ready we are to handle events.” 

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