SRI SATHYA SAI INSTITUTE OF HIGHER LEARNING

MBAG 303 (T): MANAGEMENT OF QUALITY (Theory)

COST OF QUALITY

Dr. Sanjay Mahalingam

1
WHAT IS COQ?

Cost of Quality (COQ) is a measure that quantifies the cost of

control/conformance and the cost of failure of control/non-conformance. In
other words, it sums up the costs related to prevention and detection of
defects and the costs due to occurrences of defects.

Money spent beyond expected production costs (labor, materials,

equipment) to ensure that the product the customer receives is a quality
(defect free) product. The Cost of Quality includes prevention, appraisal, and
correction or repair costs.

2
WHAT IS COQ?

Cost of Quality (COQ) = Cost of Control + Cost of Failure of Control

OR

Cost of Quality (COQ) = Cost of Good Quality + Cost of Poor Quality

3
WHY COQ?

• The language of money is essential, especially for upper management. So

COQ is required to JUSTIFY a quality effort.

• COQ helps in GUIDING the quality effort by Identifying major opportunities

for reduction in costs (of poor quality)

• COQ Provides a means to MEASURE and MONITOR the results of quality

improvement programs

• Align quality goals with organizational goals.

4
THREE DIFFERENT VIEWS ABOUT COQ

The view of quality cost among practitioners seems fall into

three categories:

FIRST
Higher quality means higher cost:

Greater quality attributes such as performance and features cost more in

terms of labor, material, design, and other costly resources. The additional
benefits from improved quality do not compensate for the additional
expenses.
5
THREE DIFFERENT VIEWS ABOUT COQ

SECOND

The cost of improving quality is less than the resultant savings:

The savings result from less rework, scrap, and other direct expenses related
to defects. This paved the way of continuous process improvement among
Japanese firms.

6
THREE DIFFERENT VIEWS ABOUT COQ
THIRD

Quality is free

Quality costs are those incurred in excess of those that would have been incurred if
product were built or service performed exactly right the first time.

This view is held by adherents of the TQM philosophy. Costs include not only those
that are direct, but also those resulting from lost customers, lost market share, and
many hidden costs and foregone opportunities not identified by modern cost
accounting systems.
7
THE COST OF POOR QUALITY !!!
o “the recall that started them all”: Johnson & Johnson’s Tylenol Recall
o A $6 Billion Shock: Merck’s Vioxx
o Halted by the accelerator: Toyota Motors’ pedals
o Explosion NOTE’d: Samsung Galaxy Note
o From world leader to Bankrupt: Takata Airbags
8
 SEE THE VIDEO

“COQ-The Martian”

9
P-A-F MODEL OF COQ

THE TRADITIONAL COQ MODEL (P-A-F model)

Conformance Costs
• Preventions Costs
• Appraisal Costs

Non Conformance Costs

• Internal Failure Costs
• External Failure Costs

10
PREVENTION COSTS
PREVENTION: Costs incurred to keep failure and appraisal costs to a minimum

• Quality planning: This includes the broad array of activities which collectively create the overall
quality plan and the numerous specialized plans. It includes also the preparation of procedures
needed to communicate these plans to all concerned.

• New products review: Reliability engineering and other quality-related activities associated with
the launching of new design.

• 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 associated effort with suppliers

• Quality training: Preparing and conducting quality-related training programs.

11
APPRAISAL COSTS
Appraisal Costs: These are the costs incurred to determine the degree of
conformance to quality requirements.

• Incoming / in-process / final inspection and tests: Determining the quality of purchased product,
whether by inspection on receipt, by inspection at the source.
• Product quality audits: Performing quality audits on in-process or finished products
• Maintaining accuracy of test equipment: Keeping measuring instruments and equipment in
calibration.
• Document review: Examination of paperwork to be sent to customer

12
INTERNAL FAILURE COSTS
Internal Failure Costs: Costs of deficiencies discovered before delivery which are
associated with the failure (non conformity) to meet explicit / implicit requirements
of internal / external customers.

• Scrap: The labor, material, and overhead on defective product that cannot economically be
repaired. The titles are numerous—scrap, spoilage, defectives, etc.
• Rework: Correcting defectives in physical products or errors in service products
• Failure analysis: Analyzing nonconforming goods or services to determine causes
• Scrap and rework – supplier: Scrap and rework due to nonconforming product received from
suppliers. This also includes the costs to the buyer of resolving supplier quality problems
• Re-inspection / retest: Re-inspection and retest of products that have undergone rework

13
INTERNAL FAILURE COSTS contd..
Internal Failure Costs: Costs of deficiencies discovered before delivery which are
associated with the failure (non conformity) to meet explicit / implicit requirements
of internal / external customers.

Changing processes: Modifying manufacturing or service processes to correct deficiencies

Changing hardware / software: Changing designs of hardware / software to correct deficiencies
Downgrading: The difference between the normal selling price and the reduced price due to quality
reasons.

14
EXTERNAL FAILURE COSTS
External failure Costs: costs associated with deficiencies found after the product is
received by the customer. Also included are lost opportunities for sales revenue

• Warranty charges: The costs involved in replacing or making repairs to products that are still
within the warranty period.
• Returned material: The costs associated with receipt and replacement of defective product
received from the field.
• Customer defections: Revenue lost due to customers who switch for reasons of quality.
• Liability Costs/Litigation
• Expensive recalls

15
1 – 10 - 100 RULE

Prevention
$ 1
Correction
$ 10

Failure

$ 100

16
PAY NOW…
or
…PAY LATER

17
 THE COST OF POOR QUALITY !!!
A president of a company in a particular industry once commented:

 A cost of $10 to "mistake-proof" an operation so no defects are produced

 A cost of $100 to find the defect and fix it during the operation before it enters the final
assembly without defect
 A cost of $1,000 to find the defect before it is shipped to the customer and replace it with a good
item
 A cost of $10,000 to have the customer find the defect, complain about it and ship them a
replacement
 A cost of $100,000 to have to do a recall of a large number of defective parts
 A cost of $1 million to handle the lawsuit that results from injury caused by the malfunction of
the defective item

So the cost of quality, the price of nonconformance, can range from $10 to$1 million
depending on where the mistake or defect is dealt with.
18
 25%
Prevention Appraisal Failure

5% 70%

30% 40% 30%

60% 35% 5%

70% 25% 5%
19
 अल्पं दृष्टं The seen is miniscule

अदृष्टं ब्र्म्हंडं The hidden is massive

HIDDEN QUALITY COSTS
Every cost (or unfulfilled opportunity) that will go away, if perfect quality
were achieved !!

1. Potential lost sales.

2. Costs of redesign of products due to poor quality.
3. Costs of changing processes due to inability to meet quality
requirements for products.
4. Costs of software changes due to quality reasons.
5. Costs of downtime of equipment and systems including computer
information systems.
21
HIDDEN QUALITY COSTS

6. 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: The purchasing buyer orders 6 percent more than the production quantity
needed.

 Allowances for scrap and rework during production: History shows that 3 percent is “normal” and
accountants have built this into the cost standards. One accountant said, “Our scrap cost is zero. The
production departments are able to stay within the 3 percent that we have added in the standard cost and
therefore the scrap cost is zero.”

 Allowances in time standards for scrap and rework: One manufacturer allows 9.6 percent in the time
standard for certain operations to cover scrap and rework.

 Extra process equipment capacity: One manufacturer plans for 5 percent unscheduled downtime of
equipment and provides extra equipment to cover the downtime. In such cases, the alarm signals ring only
when the standard value is exceeded.
22
HIDDEN QUALITY COSTS
7. Extra indirect costs due to defects and errors. Examples are space
charges and inventory charges.
8. Cost of errors made in support operations, e.g., order filling, shipping,
customer service, billing.
9. Cost of poor quality within a supplier’s company. Such costs are included
in the purchase price.
10. Can you think of some more ?

These hidden costs can accumulate to a large amount—sometimes three or

four times (or even more), the reported failure cost.

23
TRADITIONAL COQ MODEL

24
NEW COQ MODEL

25
CONTRASTING THE 2 MODELS OF COQ
The new COQ model

Exhibits a weaker increase in appraisal and prevention costs,

The total cost curve is negatively sloped and the cost optimum shifts to the
perfect quality level (Zero defects),

Reflects Deming’s viewpoint that we do not need a COQ model to

determine an optimal level of quality.

26
CONTRASTING THE 2 MODELS OF COQ

The old model is a spotlight on the technological proficiency of the time it was
constructed.

The old model obviously presupposes a company with a very poor quality level

The new model accounts for a higher prioritization of prevention and new
technological solutions that reduce the failure rate and make process monitoring
easier.

Considering unit costs, at higher quality levels, more good products are available
to bear the costs of both prevention and appraisal.

27
P-A-F COSTS IN THE SOFTWARE INDUSTRY
PREVENTION
• Staff training
• Requirements analysis
• Early prototyping
• Fault-tolerant design
• Defensive programming
• Clear specification
• Accurate internal documentation

28
P-A-F COSTS IN THE SOFTWARE INDUSTRY
APPRAISAL
• Design review
• Code inspection
• Glass box testing
• Black box testing
• Training testers
• Beta testing
• Pre-release out-of-box testing by customer service staff

29
P-A-F COSTS IN THE SOFTWARE INDUSTRY
INTERNAL FAILURE
• Bug fixes
• Regression testing
• Wasted in-house user time
• Wasted tester time
• Wasted programmer time
• Wasted marketer time
• Wasted advertisements
• Direct cost of late shipment
• Opportunity cost of late shipment
30
P-A-F COSTS IN THE SOFTWARE INDUSTRY
EXTERNAL FAILURE
• Technical support calls
• Preparation of support answer books (Trouble shooting guides)
• Investigation of customer complaints
• Refunds and recalls
• Shipping of updated product
• Added expense of supporting multiple versions of the product in the field
• Lost sales
• Lost customer goodwill
• Warranty costs
• Liability costs
• All other costs imposed by law
31
POSSIBLE LIMITATIONS OF COQ APPROACH
COQ has a tendency to be short term

Quality costs are subject to judgment and estimation and can be

controversial

Important costs can be easily omitted from the COQ calculation

(Particularly hidden costs)

Standard accounting conventions do not support COQ

32