Total Cost of Quality

The concept of quality costs is a means to quantify the total cost of quality-related efforts and deficiencies (Wikipedia). The cost of poor quality is the annual monetary loss of products and processes that are not achieving their quality objectives. The cost of poor quality is important in reducing costs and customer dissatisfaction. It can also be referred to as the cost of poorly performing processes (COP) (Wikipedia, Gryna 2007).

Categories of Quality Costs

External Failure Costs

External failure costs are associated with deficiencies that are found after the customer receives the product. Also included are lost opportunities for sales revenue.

Failure to meet customer requirements and needs

• Warranty charges – the costs involved in replacing or making repairs to products that are still within the warranty period.
• Complaint adjustments – the costs of investigation and adjustment of justified complaints attributable to defective product or installation.
• Returned material – the costs associated with receipt and replacement of defective product received from the field.
• Allowances – the costs of concessions made to customers due to substandard products accepted by the customer as is or to conforming product that does not meet customer needs.
• Penalties due to poor quality – this category applies to goods or services delivered or to internal processes such as late payment of an invoice resulting in a lost discount for paying on time.
• Rework on support operations – correcting errors on billing and other external processes.
• Revenue losses in support operations – an example is the failure to collect receivables from some customers.

Lost opportunities for sales revenue

• Customer defections – profit on potential customers lost because of poor quality.
• New customers lost because of lack of capability to meet customer needs.

Internal Failure Costs

Internal failure costs are the cost of deficiencies discovered before delivery that are associated with the failure to meet explicit requirements or implicit needs of customers. Also included are avoidable processes losses and inefficiencies that occur even when requirements and needs are met. Internal failure costs consist of: (1) the cost of failure to meet customer requirements and needs and (2) the cost of inefficient processes.

Failure to meet customer requirements and needs

• Scrap – the labor, material, and (usually) overhead on defective product that can not be repaired economically.
• Rework – correcting defectives in physical products or errors in service products.
• Lost or missing information – retrieving information that should have been supplied
• Failure analysis – analyzing nonconforming goods or services to determine causes
• Scrap and rework / supplier – scrap and rework because of nonconforming product received from suppliers
• One hundred percent sorting inspection – finding defective units in product lots that contain unacceptably high levels of defectives
• Reinspection, retest – reinspection and retest of products that have undergone rework or other revision.
• Changing processes – modifying manufacturing or service processes to correct deficiencies.
• Redesign of hardware – changing designs of hardware to correct deficiencies.
• Redesign of software – changing designs of software to correct deficiencies.
• Scrapping of obsolete product – disposing of products that have been superseded.
• Scrap in support operations – defective items in indirect operations.
• Rework in internal support operation – correcting defecting items in indirect operations
• Downgrading – the difference between the normal selling price and the reduced price because of poor quality.

Cost of inefficient processes

• Variability of product characteristics – losses that occur even with conforming product (e.g. overfill of packages due to variability of filling and measuring equipment).
• Unplanned downtime of equipment – loss of capacity of equipment due to failures.
• Inventory shrinkage – loss due to the difference between actual and recorded inventory amounts.
• Variation of process characteristics form “best practice” – losses due to cycle time and costs of process compared to best practices in providing the same output, the best practice process may be internal or external to the organization.
• Non-value-added activities – redundant operations, sorting inspections, and other non-value-added activities. A value-added activity increases the usefulness of a product to the customer; a non-value-added activity does not.

Appraisal Costs

Appraisal costs are incurred to determine the degree of conformance to quality requirements.

• Inspection and test – determining the quality of purchased product, whether by inspection on receipt, by inspection at the source, or by surveillance.
• In-process inspection and test – in process evaluation of conformance to requirements
• Final inspection and test – evaluation of conformance to requirements for product acceptance.
• Document review – examination of paperwork to be sent to the customer.
• Balancing – examination of various accounts to assure internal consistency.
• Product quality audits – performing quality audits on in-process or finished products.
• Maintaining accuracy of test equipment – keeping measuring instruments and equipment calibrated.
• Inspection and test materials and services – materials and supplies in inspection and test work and services where significant.
• Evaluation of stocks – testing products in field storage or in stock to evaluate degradation.

Prevention Costs

Prevention costs are incurred to keep failure and appraisal costs to a minimum.

• Quality planning – this category includes the broad array of activities that collectively create the overall quality plan and the numerous specialized plans.
• New products review – reliability engineering and other quality-related activities associated with the launching of a new design.
• Process planning – process capability studies, inspection planning, and other activities associated with the manufacturing and service processes
• Process control – in-process inspection and test to determine the status of the process (rather than for product acceptance).
• Quality audits – evaluating the execution of activities in the overall quality plan
• Supplier quality evaluation – evaluating supplier quality activities prior to supplier selection, auditing the activities during the contract, and performing associated effort with suppliers.
• Training – preparing and conducting quality-related training programs.

The compilation of prevention costs is initially important because it highlights the small investment currently made (usually) in prevention activities and suggests the potential for an increase in prevention costs to reduce failure costs. One of the issues in calculating the cost of poor quality is how to handle overhead costs. Three approaches are common: include total overhead using direct labor or some other base, include variable overhead only (the usual approach), or do not include overhead at all.

Hidden Quality Costs

The cost of poor quality may be understated because of costs that are difficult to estimate. “Hidden” costs occur in both manufacturing and service industries and include the following:

• Potential lost sales
• Costs of redesign of products due to poor quality
• Costs of changing processes due to inability to meet quality requirements for products
• Costs of software changes due to quality reasons
• Costs of downtime of equipment and systems including computer information systems
• Costs included in standards because history shows that a certain level of defects is inevitable and allowances should be included in standards
• Extra material purchased
• Allowances for scrap and rework during production
• Allowances in time standards for scrap and rework
• Extra process equipment capacity
• Extra indirect costs due to defects and errors
• Scrap and errors not reported
• Extra process costs due to excessive product variability (even though within specification limits)
• Cost of errors in support operations (e.g. order filling, shipping, customer service, billing)
• Cost of poor quality within a supplier’s company

For manufacturing organizations the annual cost of poor quality is about 15% of sales income, varying from about 5 to 35% depending on product complexity. For service organizations the average is about 30% of operating expenses, varying from 25 to 40% depending on service complexity.