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IE 475

Advanced ManufacturingCosting Techniques

Lecture Notes #6

Cost of Quality

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Learning Objectives

After completing this module, IE 475students should be able to:

Understand the strategic importance of quality Understand the differences between the twotypes of conformanceUnderstand the four major categories of quality

costs

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Introduction

Prior to 1950 there was very little tracking ofquality costs

Much of the costs appeared in overheadcategories

Since then, quality costs have been steadilyrising and they can be significant

Costs of Quality (CoQ) are associated solelywith defective product

Making, finding, repairing and avoiding

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Hidden Costs of Poor Quality

Adapted from Juran, J.M., Gyrna F.M. (1993), Qual ity P lann ing and Analys i s , Third Edition, McGraw-Hill, Inc., New York

Reprocessing

Rejects Sorting Inspection

Customer Returns

Warranty Expenses

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Cost Management Paradigms

Traditional CostManagement Strategic Cost Management

Normal allowance for

scrap and rework

Overhead varianceanalysis encourages

maximum productionquantity not qualityFinancial measures only

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Cost Management Paradigms (cont.)

Traditional CostManagement Strategic Cost Management

No tracking of customer

acceptanceNo COQ analysis

Top tier of referencegroup

Meet standards

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Why is Quality important?

IncreasedBusiness

Volume

QualityProducts

&Services

Greatercustomer

satisfaction

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Conceptual Linkage betweenQuality and Profitability

Product quality and profitability are closelyrelatedBusinesses that offer premium-qualityproducts and services are more likely tohave large market sharesQuality relates positively to a higher returnon investment

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Conceptual Linkage betweenQuality and Profitability (cont.)

LowerReturnSales

LowerMfg Cost

HigherPerceived

Value

FasterThroughput

Time

Lower

WarrantyandServiceCosts

Higher

Prices

Improved Quality

Higher

MarketShare

Faster

Delivery

IncreasedRevenues

Financial Performance

LowerInventory

MoreSatisfied

Customers

Higher

Turnover

Investments in Quality

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Types of Quality Conformance

Quality involves conformance with specificationsfor products or services that meet or exceedcustomer requirements and expectationsConformance, however, can differ amongindividuals or firmsTypes of Quality Conformance

Goalpost Absolute

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Types of Quality ConformanceGoalpos t Confo rm anc e

Conformance to a quality specification expressed as aspecified range around the target

Target is the ideal or desirable outcome of the operation

Goalpost conformance assumes that the firm incurs noquality or failure cost or loss if quality measures fallwithin the specified limits

Considered a zero-defect conformance

Loss No Loss Loss

Lower Target Upper Limit Value Limit

.45 .50 .55

ThicknessThickness

Loss No Loss Loss

Lower Target Upper Limit Value Limit

.45 .50 .55

ThicknessThickness

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0.50Target Value

Losses

Types of Quality ConformanceA bs olu te Con form anc e

Absolute quality conformance requires that allproducts or services meet exactly the target valuewith no variation allowed

Also referred to as robust quality approach

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Analysis of Quality CostsQuality per the Gurus

Taguchi - there is increasing loss for the producer, thecustomer, and society associated with increasingvariability or deviation from a target value that reflectsthe ideal state.

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Analysis of Quality CostsTagu ch i Lo ss Func t ion

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Quality Loss Function

For a quality characteristic with the target valueT , the loss from having a quality characteristic x can be estimated by this quadratic function:

where:x = an observed value of the quality characteristicT = the target value of the quality characteristick = the cost coefficient, determined by the firmsfailure costs

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Quality Loss Function (cont.)Your firm has determined that no customer will acceptsheet- metal deviating more than .05 from the targetvalue in thickness, that the target thickness is .50, andthat the cost to the firm is $5,000 for each rejection by acustomer

If the actual thickness of a unit is .47, then the estimatedtotal loss for the unit is:

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Analysis of Quality CostsQuality per the Gurus

Deming - Do not perform quality cost analysis.Spend the money upfront to do the right thingsthe first time.Crosby - Perform a special one time COQanalysis to assess the stage of qualitymanagement. Quality is free.

Juran - Prepare cost of quality reporting on aperiodic basis and use as a management controltool. Economic tradeoff between cost andquality.

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Costs of QualityPrevention

Expenditures incurred to keep quality defects fromoccurring

Appraisal

Costs incurred in the measurement and analysis ofdata to find out if products and services conform tospecification

Internal failureCosts incurred as a result of poor quality foundthrough appraisal prior to delivery to customers

External failureCosts incurred to rectify quality defects afterunacceptable products or services reach thecustomer

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Costs of Quality (cont.)Prevent ion co s ts include:

Ap pra isa l co s t s include:

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Costs of Quality (cont.)Internal fa ilure co sts include:

External fa i lure cos ts include:

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Categories of Quality CostsWhere i s the m on ey s pent?

Many companies have high internal and externalfailure costs

And often times appraisal costs are higher thanpreventionConcentrate on prevention

One rule of thumb is that every $1 spent on

prevention can save $10 in appraisal and failure costs

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Conformance andNonconformance Costs

Cost of Conformity

Cost of Nonconformity

1. Prevention costs2. Appraisal costs

1. Internal failure costs2. External failure costs

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Benefits of CoQ Analysis

CoQ can link operational decisions with financialperformanceCoQ can help with the selection of improvementprojectsTo be useful, quality costs must be accurate