11 -1

CHAPTER

Quality Costs and

Productivity:
Measurement,
Reporting, and
Control

11 -2

Objectives
Objectives
1. Identify and describe the four types of quality costs.
After
this
2. Prepare a quality
coststudying
report and
explain the
After
studying
this
difference between
the conventional
chapter,
you
chapter,
you should
should view of
acceptable quality level
andto:
the view espoused by
be
be able
able
to:
total quality control.
3. Tell why quality cost information is needed and
how it is used.
4. Explain what productivity is, and calculate the
impact of productive changes on profits.

11 -3

Quality Defined
A quality product
or service is one
that meets or
exceeds customer
expectations...

11 -4

Quality Defined
on the following eight dimensions:
Performance

Durability

Aesthetics

Quality of
conformance

Serviceability
Features
Reliability

Fitness for use

11 -5

Quality Defined
on the following eight dimensions:
Performance
Aesthetics
Serviceability
Features
Reliability

How
How consistently
consistently
Durability
and
well
and
well aa product
product
The
appearance
of
The functions
appearance
functions of
tangible
Quality
of
tangible products
products
Measures
the
ease
of
Measures
the
ease
of
(style,
beauty)
(style,
beauty)
conformance
maintaining
maintaining and/or
and/or
Characteristics
of
Characteristics
ofaa
repairing
the
product
Fitness
for
use
repairing
the
product
product
that
differentiate
product
that
differentiate
The
probability
The probability that
that the
the
functionally
similar
functionally
similar
product
or
will
product
or service
service
will
products
products
perform
its
perform
its intended
intended
function
function for
for aa specified
specified
length
length of
of time
time

11 -6

Quality Defined
on the following eight dimensions:
The length of time
Performance
aAproduct
measurefunctions
of how
a product
meets its
Aesthetics
specifications
The suitability
of the

Serviceability

product for carrying

out its advertised
Features
functions

Reliability

Durability
Quality of
conformance
Fitness for use

11 -7

Quality Defined

A defective product
is one that does not
conform to
specifications.

11 -8

Quality Defined
Zero defects
means that all
products
conform to
specifications.

11 -9

Quality Defined
The definition of quality-related activities imply
Incurred
to
Incurred
to
four categories of quality costs:
prevent
Incurred
to
prevent
poor
Incurredpoor
to
1) Preventive costs
quality
determine
quality or
or
determine
services
being
Incurred
when
whether
products
services
being
Incurred
when
whether
products
2) Appraisal costs
Incurred
produced
products
and
and
services
Incurred
when
produced
productswhen
and
and
services
3) Internal failure costs
products
and
services
not
conform
to
products
and
services
do
not
conform
todo
services
fail
to
conform
to
requirements
services
fail
to
conform
to
requirements
4) External failure costs
conform
specifications
conformto
to
specifications
requirements
requirements after
after
being
being delivered
delivered

Examples of Quality Costs

Prevention costs
Quality engineering
Quality training programs
Quality planning
Quality reporting
Supplier evaluation and selection
Quality audits
Quality circles
Field trials
Design reviews

11 -10

Examples of Quality Costs

Appraisal Costs
Inspection of raw materials
Testing of raw materials
Packaging inspection
Supervising appraisal
Product acceptance
Process acceptance
Inspection of equipment
Testing equipment
Outside endorsements

11 -11

Examples of Quality Costs

Internal failure costs
Scrap
Rework
Downtime (defect related)
Reinspection
Retesting
Design changes

11 -12

Examples of Quality Costs

External failure costs
Cost of recalls
Lost sales
Returns/allowances
Warranties
Repairs
Product liability
Customer dissatisfaction
Lost market share
Complaint adjustment

11 -13

11 -14

Measuring Quality Costs

Hidden Quality Costs are
opportunity costs resulting from
poor quality.
The Multiplier Method
The Market Research Method
Taguchi Quality Loss Function

11 -15

The Multiplier Method

The multiplier method assumes that the total failure
cost is simply some multiple of measured failure
costs:
Total external failure cost = k(Measured external
failure costs)
where k is the multiplier effect
If k = 4, and the measured external failure costs are $2
million, then the actual external failure costs are estimated
to be $8 million.

The Market Research Method

11 -16

The market research method uses formal market

research methods to assess the effect of poor quality
on sales and market share.
Customer surveys and interviews with members
of a companys sales force can provide significant
insight into the magnitude of a companys hidden
costs.
Market research results can be used to project
future profit losses attributable to poor quality.

11 -17

The Taguchi Quality Loss Function

The Taguchi loss function assumes any variation
from the target value of a quality characteristic
causes hidden quality costs.
Furthermore, the hidden quality costs increase
quadratically as the actual value deviates
from the target value.

The Taguchi Quality Loss Function

$
Cost

Lower
Specification
Limit

Target
Value

Upper
Specification
Limit

11 -18

The Taguchi Quality Loss Function

L(y) = k(y T)
k = A proportionately constant dependent
upon the organizations external failure
cost structure
y = Actual value of quality characteristic
T = Target value of quality characteristic
L = Quality loss

11 -19

11 -20

Quality Cost Report

Unit Actual Diameter (y)

y-T

(y T)

k(y-T)

9.9

-0.10

0.010

$ 4.00

10.1

0.10

0.010

4.00

10.2

0.20

0.040

16.00

9.8

-0.20

0.040

16.00

Total

0.100

$40.00

Average

0.025

$10.00

Image Products
Quality Cost Report
For the Year Ended March 31, 2004
Prevention costs:
Quality training
Reliability engineering
Appraisal costs:
Materials inspection
Product acceptance
Process acceptance
Internal failure costs:
Scrap
Rework
External failure costs:
Customer complaints
Warranty
Repair
Total quality costs

1111-22
-21

Quality Costs

% of Sales

$35,000
80,000

$115,000

4.11%

$20,000
10,000
38,000

68,000

2.43

$50,000
35,000

85,000

3.04

$25,000
25,000
15,000

65,000
$333,000

2.32
11.90%

11 -22

Relative Distribution of Quality Costs

External
Failure
(19.5%)

Internal
Failure
(25.6%)

Prevention
(34.5%)

Appraisal
(20.4%)

11 -23

Quality Cost Graph

Total
Quality
Costs

Cost

Failure Costs

Control Costs
0
AOL
Percent Defects

100%

11 -24

Contemporary Quality Cost Graph

Cost

Total
Quality
Costs

Failure Costs

Control Costs
100%

0
Percent Defects

Trend Analysis

11 -25

Assume
Assume the
the following
following data:
data:
2000
2001
2002
2003
2004

Quality Costs
$440,000
423,000
412,500
392,000
280,000

Actual Sales
$2,200,000
2,350,000
2,750,000
2,800,000
2,800,000

% of Sales
20.0%
18.0
15.0
14.0
10.0

Multiple-Period Trend Graph:

Total Quality Costs
% of
Sales
20
15
10
5

Year

3
5

11 -26

Multiple-Trend Analysis for

Individual Quality Costs
Assume the following quality cost data:

2000
2001
2002
2003
2004
1

Prevention

Appraisal

Internal
Failure

2.0%1
3.0
3.0
4.0
4.1

2.0%
2.4
3.0
3.0
2.4

6.0%
4.0
3.0
2,5
2.0

Expressed as a % of sales

External
Failure

10.0 %
8.6
6.0
4.5
1.5

11 -27

Multiple-Period Trend Graphic:

Individual Quality Cost Categories
Percentage
of Sales

10
9
8
7
6
5
4
3
2
1
0

11 -28

Prevention
Appraisal
Internal failure
External failure

Year

Productivity: Measurement
and Control

11 -29

Productivity
Productivity isis concerned
concerned
with
with producing
producing output
output
efficiently,
efficiently,and
and isis itit
specifically
specifically addresses
addresses the
the
relationship
relationship of
of output
output and
and
the
the inputs
inputs used
used to
to produce
produce
the
the outputs.
outputs.

Productivity: Measurement
and Control
Total productive efficiency is the point at
which two conditions are satisfied:
1. for any mix of inputs that will produce
a given output, no more of any one
input is used than necessary to produce
the output
2. given the mixes that satisfy the first
condition, the least costly mix is
chosen.

11 -30

Technical Efficiency
Technical Efficiency is the condition where no more of any
one input is used than necessary to produce a given output.

Technical efficiency improvement is when less

inputs are used to produce the same output or
more output are produced using the same input.
Current productivity
Inputs:
Labor
Capital

Outputs:

11 -31

Technical Efficiency
Same Output, Fewer Inputs
Inputs:
Outputs:
Labor

Capital

More Output, Same Inputs

Inputs:
Outputs:
Labor
Capital

11 -32

Technical Efficiency
More Output, Fewer Inputs
Inputs:
Outputs:
Labor

Capital

Technically Efficient Combination I:

Inputs:
Outputs:
Labor

Capital
$20,000,000

11 -33

Technical Efficiency

11 -34

Technically Efficient Combination II:

Inputs:
Outputs:
Labor

Capital
$25,000,000

Of
Of the
the two
two combinations
combinations that
that produce
produce the
the same
same output,
output,
the
the least
least costly
costly combination
combination would
would be
be chosen.
chosen.

11 -35

Partial
Partial Productivity
Productivity Measurement
Measurement
Partial Productivity Measurement: Measuring
productivity for one input at a time.
Partial Measure = Output/Input
Operational Productivity Measure: Partial measure
where both input and output are expressed in
physical terms.
Financial Productivity Measure: Partial measure
where both input and output are expressed in
dollars.

11 -36

Profile measurement provides a

series or a vector of separate and
distinct partial operational measures.

11 -37

Profile Productivity Measures

Example 1:
The productivity of both labor labor and materials
moves in the same direction:
Number of motors produced
Labor hours used
Materials used (lbs.)

Labor productivity ratio

Material productivity ratio

2003
120,000
40,000
1,200,000

2004
150,000
37,500
1,428,571

150,000/37,500
150,000/37,500
Partial Productivity Ratios
150,000/1,428,571
150,000/1,428,571

2003 Profile

2004 Profile

3.000
0.100

4.000
0.105

11 -38

Profile Productivity Measures

Example 2:
Assume the same data as Example 1 except the material
used is 1,700,000 pounds.
Number of motors produced
Labor hours used
Materials used (lbs.)

Labor productivity ratio

Material productivity ratio

2003
120,000
40,000
1,200,000

2004
150,000
37,500
1,700,000

150,000/37,500
150,000/37,500
Partial Productivity Ratios
150,000/1,700,000
150,000/1,700,000

2003 Profile

2004 Profile

3.000
0.100

4.000
0.088

Profit-Linked
Profit-Linked Productivity
Productivity
Measurement
Measurement
Profit-Linkage Rule: For the current period, calculate
the cost of the inputs that would have been used in the
absence of any productivity change, and compare this
cost with the cost of the inputs actually used. The
difference in costs is the amount by which profits
changed because of productivity changes.
To compute the inputs that would have been used
(PQ), use the following formula:
PQ = Current Output/Base-Period Productivity Ratio

11 -39

Profit-Linked
Profit-Linked Productivity
Productivity
Measurement
Measurement
Example: Kunkul provided the following data:
2003
Number of motors produced 120,000
Labor hours used
40,000
Materials used (lbs.)
1,200,000
Unit selling price (motors)
$50
Wages per labor hour
$11
Cost per pound of material
$2

2004
150,000
37,500
1,700,000
$48
$12
$3

11 -40

Profit-Linked
Profit-Linked Productivity
Productivity
Measurement
Measurement
PQ (labor) = 150,000/3 = 50,000 hrs.
PQ (materials) = 150,000/0.100 = 1,500,000 lbs.
Cost of labor: (50,000 x $12)
Cost of materials: (1,500,000 x $3)
Total PQ cost

$ 600,000
4,500,000
$5,100,000

The actual cost of inputs:

Cost of labor: (37,500 x $12)
Cost of materials: (1,700,000 x $3)
Total current cost

$ 450,000
5,100,000
$5,550,000

11 -41

Profit-Linked
Profit-Linked Productivity
Productivity
Measurement
Measurement
Profit-linked effect = Total PQ cost - Total current cost
= $5,100,000 $5,550,000
= $450,000 decrease in profits
The net effect of the process change was
unfavorable. Profits declined $450,000
because of productivity changes.

11 -42

Price-Recovery Component

11 -43

The difference between the total profit change and the

profit-linked productivity change is called the pricerecovery component.
2004
Revenues
Cost of inputs
Profit

$7,200,000
5,550,000
$1,650,000

2003

Difference

$6,000,000 $ 1,200,000
2,840,000 2,710,000
$3,160,000 $-1,510,000

Price recovery = Profit change Profit-linked productivity change

= $1,510,000 $450,000
= $1,060,000

11 -44

Chapter Eleven

The
The End
End

11 -45