Chapter-2-Cost-of-Quality.pdf

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. CHAPTER 2 The cost of poor quality can add to other costs such as design, production, maintenance, inspection, sales,...

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. CHAPTER 2 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. COST OF QUALITY The price of nonconformance (Philip Crosby) or the cost of poor quality (Joseph Juran), the term 'Cost of Quality', refers to the costs associated with providing poor quality product or service. 2 1 Understand Quality Costs WHY CALCULATE QUALITY COST • Understand quality costs enables you to – Understand hidden costs – Reduce and eliminate unnecessary cost • Prevent problems from happening • Management responsibility to enable this • 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 • 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 • By front-line operator • By middle management 3 4 WHAT DO YOU THINK? WHAT DO YOU LEARN? 5 6 TOTAL QUALITY MANAGEMENT (TQM) Founders Point of View • Phillip B. Crosby (Quality is free): • “Quality is free. It’s 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.” • 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 7 Customers will seek out the highest quality product. Therefore, quality is “free”. Improved quality that exceeds customer expectations will generate more revenues that exceed the cost of quality. 8 TOTAL QUALITY MANAGEMENT (TQM) W. Edwards Deming proposed that improving quality reduces cost and improves profitability. RETURN ON QUALITY (ROQ) Quality can be and should be improved continuously. Profit is maximized at the optimum quality level. The optimum quality level is always achieved before maximum attainable profit is reached. Cost Revenues Revenues Max Profit Max Profit Cost Optimum Quality Max Quality Total Quality Management - Spring 2010 - IUG 10 9 Founders Point of View COST OF QUALITY • Cost of Achieving Good Quality • Prevention costs • Feigenbaum (Originator of ‘Total Quality’ • costs incurred during product design concept) • Appraisal costs Definition of Quality costs (1956) • costs of measuring, testing, and analyzing Appraisal costs Prevention costs Failure costs • 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 11 12 EXAMPLES OF PREVENTION COST PREVENTION COSTS • Quality planning costs • costs of developing and implementing quality management program • Product-design costs • costs of designing products with quality characteristics • Process costs • costs expended to make sure productive process conforms to quality specifications • Training costs • Application screening • costs of developing and putting on quality training programs for employees and management • Information costs • costs of acquiring and maintaining data related to quality, and development of reports on quality performance • 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 13 APPRAISAL COSTS 14 EXAMPLES OF APPRAISAL COST • 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 15 • Audit • Laboratory test • Document checking • Personnel testing • Diagram checking • Procedure testing • Equipment calibration • Prototype inspection • Final inspection • Receiving inspection • In-process inspection • Shipping inspection 16 INTERNAL FAILURE COSTS • Scrap costs • costs of poor-quality products that must be discarded, including labor, material, and indirect costs • Rework costs • costs of fixing defective products to conform to quality specifications • Process failure costs • costs of determining why production process is producing poor-quality products EXTERNAL FAILURE COSTS • Customer complaint costs • Process downtime costs • costs of shutting down productive process to fix problem • Price-downgrading costs • costs of discounting poorquality products—that is, selling products as “seconds” • costs of investigating and satisfactorily responding to a customer complaint resulting from a poor-quality product • Product return costs • costs of handling and replacing poor-quality products returned by customer • Warranty claims costs • costs of complying with product warranties • Product liability costs • litigation costs resulting from product liability and customer injury • Lost sales costs • costs incurred because customers are dissatisfied with poor quality products and do not make additional purchases 17 18 CLASSIFYING QUALITY COSTS Defects, Scrap, Rework, Inspection, Returns, Warranty, Quality Assurance Prevention Appraisal Design Review, Zero Defects Program, Supplier Training, Supplier Evaluation, Specification Review, Quality Audits, Preventive Maintenance, Engineering Changes, Product Liability, Increased Overhead Vendor Surveillance, Receiving Inspection, Product Acceptance, Process Control, Inspection Labor, Quality Control Labor, Testing Equipment Costs Internal Failure External Failure Downtime, Engineering Changes, Excess Inventory, Disposal Costs, Reinsertion Consumer Affairs, Purchase Changes, Service after Sales, Product Liability, Lost Market Share Delivery Delay 19 20 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. 21 COST OF QUALITY (OTHER 22 BENEFITS OF USING QUALITY COSTING VERSION) • Greater accuracy in the evaluation and forecasting of resource use 2. These two main areas can be split further as shown below: FIGURE 1.3 • 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 23 24 BENEFITS OF USING QUALITY COSTING (2) • Ability to set cost-reduction targets and then to measure and report progress WHO: Fighting COVID-19 could cost 500 times as much as pandemic prevention measures What should we do next? Open or close? • Ability to produce “local” data which improves understanding of resource utilization objectives and targets at all levels throughout the company Vaccination is the best solution? • 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 25 THE 1:10:100 RULE: 1-10-100 Rule $ Correction $ Failure One dollar spent on prevention will save $10 on appraisal and $100 on failure costs. 1 Prevention 26 $ 10 $ This rule helps one to prioritize expenditure on prevention, which is sure to bring in greater returns. 100 $ $ $ $ $ $ 27 “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 don’t find it until it has been soldered into a computer component, it may cost $10 to repair the part. If you don’t catch the component until it is in the computer user’s 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.” 28 Preventing Poor Quality (Comparison) DIFFICULTIES IN USING QUALITY COSTING Prevention Costs Management have not believed in the possibilities of improvement Benefit Appraisal Costs $ Quality costing is demanding ◦ It requires a lot of data of each activity related to quality Repair Costs Prevention Costs Failure Costs • Internal • External Appraisal Costs Before Quality Cost Alignment After Quality Cost Alignment Other limitations ◦ ◦ ◦ ◦ ◦ ◦ Repair Costs Failure Costs 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 29 30 Preventing Poor Quality 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 31 • Would it not make sense to prevent poor quality products from happening? • How can this be done? • Whose responsibility is this? 32 How to Prevent Poor Quality Determine Quality Cost Categories • 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 • • • • • Understand your product Understand your process Understand where problems occur Determine precisely what goes wrong Determine what costs represents each problem 33 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 34 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 35 36 Analyse Collected Data Useful Quality Cost Knowledge • Data on its own is useless • You must have it analysed to be able to extract meanings • Determine what knowledge you require • Develop an analysis system that provides the knowledge you require • • • • 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 37 38 HISTORY OF ACTIVITY-BASED COSTING Management is Responsible Term “activity-based costing” created in 1975 by Dr. Robert Kaplan • 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 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…) 39 40 BENEFITS ASSOCIATED WITH ABC More precise cost information 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. Improved cost control and management Improved insight into cost causation • 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. Better performance measures 42 41 QUALITY AND PRODUCTIVITY Effective quality improvement can be instrumental in increasing productivity and reducing cost. END OF CHAPTER 2 The cost of achieving quality improvements and increased productivity is often small. 43 44