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James Wells

Lean

What Is Your True Cost of Quality?

Learn to speak the language of business, time, and dollars

Published: Monday, March 1, 2021 - 13:03

When is a product “good enough” to accept? This is the classic challenge of quality. High customer expectations demand that suspect products be thoroughly scrutinized and a high standard set for their release. Customers expect this, and quality staff strive to achieve it.

The other side of the tug of war is cost. Business leaders are looking for every advantage they can get in reducing their costs, and scrap products are one of the biggest targets out there. Sometimes it seems that quality leaders and business leaders don’t even speak the same language. Quality leaders talk with great animation about “doing the right thing for the customer,” while business leaders talk in terms of time and money.

Does it have to be this way? Can quality and business be on the same side?

In short, the answer is yes. What is required is a change in language, attitude, and approach about quality. The two models below help to illustrate the different attitudes about quality. The tool is a cost-of-quality metric set. There are generally two schools of thought on quality cost behavior. The opposing viewpoints are illustrated below.

In the economic conformance model, the classic quality-vs.-cost struggle is portrayed. The underlying philosophy here is that high quality costs extra, and that there exists a point of diminishing returns. That point is called the economic conformance level (ECL). The ECL is the point above which higher quality is more costly to achieve than it’s “worth.” This viewpoint pits those with “quality” in their job title against those without in a dance to determine where the ECL exists for the business; it promotes a “good enough” rationalization mindset that permeates every product-quality decision eventually.

Figure 1: Economic conformance level

For a different perspective, we turn to the work of Phillip Crosby. Crosby developed a four-part quality philosophy through years of proven experience, as expressed in his 1978 book, Quality Is Free (Mentor, 1980). The four components of Crosby’s philosophy are:
1. The definition of quality is conformance to requirements
2. The system of quality is prevention
3. The performance standard is zero defects
4. The measurement of quality is the price of nonconformance

Crosby’s approach is illustrated below in the “quality is free” perspective on quality costs.

Fig. 2: A “Quality is free” perspective. Prevention and appraisal costs do not intersect with internal and external failure costs when external failure costs are correctly specified.

Essentially, what Crosby’s model illustrates is that there is no economic conformance point in the quality cost model when all quality costs are considered. In other words, the cost of prevention can never exceed the “real and true” cost of letting the defect exist and go to the customer.

Building a comprehensive cost-of-quality metrics set and educating business leaders on the elements of it begins to build the bridge of translation that quality leaders need to start speaking the language of business when they are talking about quality issues to people who are concerned about the bottom line.

Where do we start? Let us start with defining the four major elements of a cost-of-quality metrics set. These are:
1. Prevention costs. Those costs associated with preventing defects from occurring.
2. Appraisal costs. Those costs associated with inspection of product to detect defects. Be careful not to conflate the cost of doing inspection with the cost associated with the defects resulting from inspection; they are different and should be counted separately.
3. Internal failure costs. Those costs associated with defects we find in-house, before the product leaves our facility. The largest bucket of cost here is typically scrap or rework, depending on the product and the operation.
4. External failure costs. Those costs associated with defects that are found by the customer. Typically, the largest bucket of costs here would be warranty or replacement costs.

There are some rules of thumb to consider when building and then reviewing cost of quality. A few of them are:
• Prevention and appraisal costs are “good” quality costs. We should want to increase these in the ratio to the other costs.
• Internal and external failure are “poor” quality costs. We should want to decrease these overall and in the ratio to the good quality costs.
• The desired ratio of poor quality costs to overall quality costs should be no more than 20 percent.
• A typical manufacturing organization can see its poor-quality costs as high as 20 percent of its revenues and higher than 80 percent of the total quality costs.
• A defect found at the customer is, in general, seven to 10 times more costly than the prevention of that defect, when all costs are considered. If our cost-of-quality model does not approximately reflect this rule, then there are costs out there that are not accounted for.

There are three categories of costs to consider when building your cost-of-quality model.

First is what I call “line item” cost. These costs are present on the balance sheet and can be easily extracted and collected together. Depending on the granularity of the accounting system, some costs that you can expect to find on the balance sheet might include inspection labor, scrap, warranty costs, settlements, equipment purchases, and maintenance contracts. Unless you have your employees sign in and out of jobs, you will need to apply some assumptions about labor time.

The second category of costs are “activity-based” costs. These costs are not captured in the balance sheet and not at the level of granularity needed to bucket them properly. For instance, you might find that the entire quality department is one line in the balance sheet, or that labor is one bucket. Activity-based cost looks at activities that are performed and assigns some costs to them based on assumptions about the amount of time that activity typically takes multiplied by the number of occurrences of that activity.

The third category are “soft costs.” These costs are not found on the balance sheet but exist in the headwinds the business experiences because of poor quality. With some work, these costs can be estimated. An example of a soft cost would be something associated with loss of sales due to quality issues or lost reputation.

It is rare for an organization to have the level of granularity in its business processes to generate an all-in cost of quality entirely from the balance sheet. Some activity-based estimations are needed to capture those costs that are buried, and soft cost calculations are an “off-balance-sheet” exercise entirely.

Building a cost-of-quality model is an iterative process and takes at least two revisions to get it where it needs to be for your business. However, even with the first version, there will be actionable messages that fall out of the cost-of-quality data about what issues to attack. My suggestion is use these as justification and feed those into your continuous improvement program to drive action on them.

Cost of quality is the translator that quality leaders can use to start to learn how to speak the language of business, time, and dollars. It is also the translator that allows business leaders to start to learn about the impact of their quality-related decision-making. A well-constructed, comprehensive cost-of-quality metric set should feed a robust, periodic review process, and becomes an engine that drives and focuses your continuous improvement efforts in the right places to make an impact.

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About The Author

James Wells’s picture

James Wells

James Wells has been a quality professional for over 23 years, implementing quality management systems compliant with ISO 9001, ISO 14001, TS16949, FDA cGMP and TL9000 requirements. Wells has led four Lean Six Sigma deployments and accumulated over $140 million in savings over 15 years as a Master Black Belt and Lean Specialist. Wells is certified as a Six Sigma Master Black Belt and Lean Specialist. He is the Principal Consultant at Quality In Practice. He can be reached at info@qualityinpractice.solutions