Total Quality Management Total Quality Management - Spring 2010 - IUG1 Week # 7 Cost of Quality Prepared by: Khalid Dahleez Faculty of Commerce – the Islamic.

Total Quality ManagementTotal Quality Management

Total Quality Management - Spring 2010 - IUG 1

Week # 7Week # 7

Cost of QualityCost of Quality

Prepared by: Khalid DahleezPrepared by: Khalid Dahleez

Faculty of Commerce – the Faculty of Commerce – the Islamic University of GazaIslamic University of Gaza

This material was collected from different sourcesThis material was collected from different sources

Understand Quality Costs• Understand quality costs enables you to

– Understand hidden costs– Reduce and eliminate unnecessary cost

• Prevent problems from happening• Management responsibility to enable this

• 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

2Total Quality Management - Spring

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Why calculate Quality CostWhy calculate Quality Cost

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

By front-line operator By middle management


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Benefits of using quality costingBenefits of using quality costing

Greater accuracy in the evaluation and forecasting of resource use

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


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Benefits of using quality costing (2)Benefits of using quality costing (2)

Ability to set cost-reduction targets and then to measure and report progress

Ability to produce “local” data which improves understanding of resource utilization objectives and targets at all levels throughout the company

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


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COST OF QUALITYCOST OF QUALITYQuality 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.

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.

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.


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7

• Phillip B. Crosby (Quality is free . . . ):

• 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 Non-conformance.

• Cost of quality is only the measure of operational performance

• “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.”

Founders Point of View

Total Quality Management - Spring 2010 - IUG

Customers will seek out the highest quality

product.

Customers will seek out the highest quality

product.

Improved quality that exceeds customer expectations will

generate more revenues that exceed the cost of quality.

Improved quality that exceeds customer expectations will

generate more revenues thatexceed the cost of quality.

Therefore, quality is

“free.”

,Therefore quality is

free“.”

Total Quality Management Total Quality Management (TQM)(TQM)


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Total Quality Management Total Quality Management (TQM)(TQM)

W. Edwards Deming proposed that improving quality reduces cost and

improves profitability.

W. Edwards Deming proposed that improving quality reduces cost and

improves profitability.Quality can be and should be

improved continuously.

Quality can be and should beimproved continuously.

Revenues

Cost

Max Profit

Max Quality


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Return on Quality (ROQ)Return on Quality (ROQ)

Profit is maximized at the optimum quality level.

Profit is maximized at theoptimum quality level.

The optimum quality level is always achieved before maximum attainable profit is reached .

Theoptimum quality level is always achieved beforemaximum attainable profitis reached .

Revenues

Cost

Max Profit

Optimum Quality


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• Feigenbaum (Originator of ‘Total Quality’ concept)Definition of Quality costs (1956)

Appraisal costsPrevention costsFailure costs

Founders Point of View


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Cost of QualityCost of Quality Cost of Achieving Good Quality

◦ Prevention costs costs incurred during product design

◦ Appraisal costs costs of measuring, testing, and analyzing

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


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Prevention CostsPrevention CostsQuality 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◦ 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


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Examples of prevention CostExamples of prevention Cost◦ Application screening

◦ 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


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Appraisal CostsAppraisal Costs

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 productsOperator 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


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Examples of appraisal costExamples of appraisal cost

Audit Document checking Diagram checking Equipment calibration Final inspection In-process inspection

Laboratory test Personnel testing Procedure testing Prototype inspection Receiving inspection Shipping inspection


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Internal Failure CostsInternal Failure CostsScrap 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

Process downtime costs◦ costs of shutting

down productive process to fix problem

Price-downgrading costs◦ costs of discounting

poor-quality products—that is, selling products as “seconds”


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External Failure CostsExternal Failure CostsCustomer complaint

costs◦ 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


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Defects, Scrap, Rework, Inspection, Returns, Warranty, Quality Assurance

PreventionDesign Review, Zero Defects Program, Supplier Training, Supplier Evaluation, Specification Review, Quality Audits, Preventive Maintenance, Engineering Changes, Product Liability, Increased Overhead

AppraisalVendor Surveillance, Receiving Inspection, Product Acceptance, Process Control, Inspection Labor, Quality Control Labor, Testing Equipment Costs

External FailureConsumer Affairs, Purchase Changes, Service after Sales, Product Liability, Lost Market Share Delivery Delay

Internal FailureDowntime, Engineering Changes, Excess Inventory, Disposal Costs, Reinsertion


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Classifying Quality Classifying Quality CostsCosts


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Preventing Poor Quality (Comparison)

Failure Costs• Internal• External

Failure Costs

Repair Costs

Repair Costs

Appraisal Costs

Appraisal Costs

Prevention Costs

Prevention Costs$

Before Quality Cost Alignment

After Quality Cost Alignment

Benefit


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Cost of Quality (Cost of Quality (other other version) 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.


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Cost of Quality (Cost of Quality (other other version) version)

2 .These two main areas can be split further as shown below :FIGURE 1.3


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1-10-100 Rule

$

$

$

$

$

$

$

$

$

$

1

10

100

Prevention

Correction

Failure


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The 1:10:100 rule:The 1:10:100 rule: Re.1 spent on prevention will save Rs.10 spent on

appraisal and Rs.100 on failure costs.

One dollar spent on prevention will save $10 on appraisal and $100 on failure costs.

This rule helps one to prioritize expenditure on prevention, which is sure to bring in greater returns.

“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.”


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Difficulties in using Quality costingDifficulties in using Quality costing

Management have not believed in the possibilities of improvement

Quality costing is demanding◦ It requires a lot of data of each activity related to quality

Other limitations

◦ 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


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Steps in implementing quality costSteps in implementing quality cost

1. Involve accountants right from the start2. Decide purpose and objectives3. Decide how to deal with overheads4. Distinguish between basic work and quality related

activities5. Collection data which offers the prospect of real gains6. Start by examining failure costs7. Evaluate the costs of inspection8. Analyze and use the data9. Collecting and reporting quality cost data


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Preventing Poor Quality

• Would it not make sense to prevent poor quality products from happening?

• How can this be done?• Whose responsibility is this?


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How to Prevent Poor Quality

• 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


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Determine Quality Cost Categories

• Understand your product • Understand your process• Understand where problems occur• Determine precisely what goes wrong• Determine what costs represents each

problem


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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


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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


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Analyse Collected Data• Data on its own is useless• You must have it analysed to be able to

extract meaning• Determine what knowledge you require• Develop an analysis system that provides

the knowledge you require


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Useful Quality Cost Knowledge

• 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


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Management is Responsible

• 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


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History of Activity-Based History of Activity-Based CostingCosting Term “activity-based costing” created in 1975 by Dr.

Robert Kaplan

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…)


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Benefits Associated With Benefits Associated With ABCABCMore precise cost information

Improved cost control and management

Improved insight into cost causation

Better performance measures


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DefinitionsDefinitions

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.

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.


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The Link Between Quality and The Link Between Quality and ProductivityProductivityEffective quality improvement can be

instrumental in increasing productivity and reducing cost.

The cost of achieving quality improvements and increased productivity is often small.


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Summary SlideSummary SlideThe following Slides are for

understanding only (subject to indirect Questions): “ 37, 38, 39, 40”

Other slides are required and subjects to any type of Questions

Total Quality Management - Spring 2010 41

Total Quality Management Total Quality Management - Spring 2010 - IUG1 Week # 7 Cost of Quality Prepared by: Khalid Dahleez Faculty of Commerce – the Islamic.

Documents

cost of quality quality

quality cost management

crosby quality

appraisal quality

implication of quality

term cost of quality

poor quality product

service industry quality