More than 500,000 organizations worldwide have established formal quality systems based on the popular ISO 9000 series of standards. Many of them have maintained their quality systems for five years or more. In light of an increased focus on quality and customer satisfaction, executive managers have raised the question: Are quality-related efforts worth their cost? In other words, what is quality's return on investment?

 The answer to this question is unique for every organization and is based on two fundamental conditions:

  Quality must be measurable, preferably in dollars.

  A cause-and-effect relationship must exist between quality and financial results.

How can quality be measured?

 In most organizations, the quality manager evaluates the effectiveness of the quality system. Sections 4.1 and 4.16 of ISO 9001:1994 mandate that quality records be used to demonstrate the effective operation of the quality system.

 However, many quality indicators are not expressed in common financial terms. For this reason, executive managers often find it difficult to evaluate quality-related performance. In addition, many quality managers lack the financial background that would enable them to communicate in financial terms. This dilemma can be overcome when quality managers learn to apply fundamental business management concepts, including financial principles, to the measurement of quality.

 Table 1 provides a matrix of measurable quality parameters that enable an organization to measure quality. The vertical axis contains three quality aspects: value/cost, time (usually linked to cost of labor) and quality of work results. The horizontal axis represents four major factors--people, machines, materials and methods--from Kaoru Ishikawa's cause-and-effect technique, which quality managers use frequently to analyze problems. Each field includes examples of quality measures available in most organizations; some apply more to production environments, and others relate better to service environments. Most of these meas-ures are available in monetary terms or can easily be assigned a dollar value.

Table 1: Quality-Measurement Parameters

Quality vs. finance

 Is there a cause-and-effect relationship between quality and finance? How does an organization's quality performance affect its bottom line? A simplified economic equation is useful to investigate this relationship:

profit = income - expense

 For it to affect profit, quality must affect either income or expense. How can "good" quality increase income or decrease expense? Or, alternatively, how can "poor" quality decrease income or increase expense? See Table 2 for some examples.

Table 2: Quality's Effect on Income and Expenses

There are many examples that demonstrate how "good" quality can increase income. In most industries, good references from satisfied customers are important factors for business growth. For example, existing customers are more likely to place more orders with an organization that has consistently shipped them defect-free product on time. Quality also has a service aspect for many customers. An organization that is responsive to requests and demonstrates a "can do" attitude will gain competitive advantages. In general, these benefits are obtained over medium- to long-term periods.

 Internal benefits, including cost reductions from improved quality levels, are often achieved much faster. Production costs can be reduced when production processes are streamlined or their effectiveness increased. This can be achieved through improved process control that reduces the undesirable production of bad parts. Shortened machine setup times and immediate availability of complete production information can further improve productivity. Quality professionals have studied valuable improvement techniques that lead to reductions of production cost through quality improvements.

 For example, an injection molding company was able to restructure production by linking three processes that had run independently for years. The average production time was 1.5 days per part from receipt of the order to shipment. Between each process, the company required a components inventory to ensure a short production time, as requested by its customers. After physically linking these processes, the company found that the average production time dropped to three minutes per part. At the same time, the total inventory was reduced by more than $1 million. This example demonstrates how performance improvement and a reduction of working capital were achieved through process improvement.

 Alternatively, many companies keep track of the cost of nonquality. Such costs may include express shipment cost when product is shipped overnight to meet a set delivery date, even if it was an internal problem that delayed production. Furthermore, warranty cost, as well as rework and scrap cost, is often the result of unacceptable quality levels. Quality improvements can lead to immediate cost reductions in these areas.

 Additional examples can be found in the service industry: An organization that manufactures kitchen furniture had analyzed the reasons for incoming calls to its sales and customer service department. The questions callers asked most often related to cost quotes; customers usually wanted to modify colors or materials. By changing the quotations' format so that they included alternative color and materials options in spreadsheet form, the organization reduced the number of incoming calls. The additional time made newly available was used for value-adding sales and servicing activities. The company was able to handle greater sales volume without increasing personnel. The customer receives a "better" cost quote, and the organization saves money.

 Many examples demonstrate how quality can directly affect the financial performance of an organization; however, these benefits are only measurable in retrospect. The challenge for many organizations, then, is determining how management can plan for such improvements. Where can quality improvements have an effect on the bottom line? The answer lies in identification and management of key processes, which can lead to planned improvements.

Process orientation

 All of an organization's activities can be described by a process. Common process characteristics include the input, the activities performed using the input, and the output.

 The technical process of assembly requires parts, tools and instructions as input. Assigned production personnel perform the assembly and verification activities. The output is a complete product that functions as intended.

 An example of a nontechnical process is the weekly payment of hourly personnel. The input may include timecards and employment agreements with labor rates. Accounting personnel enter data from timecards into payroll software and print paychecks. The output includes paychecks and electronic payroll records.

 Processes that are important to an organization are usually controlled. Such control may be attained by supervision, maintenance and review of records; the assignment of qualified personnel with a certain expertise; technical control through software or fixtures; or other means.

 It's important for an organization to realize that most of its processes are not controlled. This is normal and acceptable, as long as the organization has identified its major processes that require control due to their effect on overall business results, implied risks, process complexity or other relevant factors.

 Once an organization has identified its key processes and established adequate process control, quality is easily linked to financial performance. The organization can define the desired output of its key processes and monitor actual performance. The output should be defined in measurable terms, including financial terms (see Table 1). As the actual performance is compared to defined objectives, the organization will learn where it needs improvement activities. Such improvement activities will involve cause investigation and disciplined problem solving. Quality professionals should be aware of various improvement techniques used to address deficiencies in meeting requirements or objectives.

 The popular ISO 9000 series of standards is currently undergoing a planned revision. The draft international standard version was released in November 1999. The final standard, scheduled for release in the fall of 2000, will emphasize process management and, as such, will become a valuable management tool for helping many organizations identify their key processes and ensure adequate control of these processes. The ongoing process output measurement and data analysis will lead to continual improvement.

 Two additional aspects should be considered when analyzing quality's return on investment:

  Investment vs. expense

  Scope of quality

Investment vs. expense = prevention vs. correction

 In the financial world, there is a clear distinction between investments and expenses. The major difference is that investments involve expenditures, which are directly linked to measurable benefits. A certain return on investment is expected. Over time, the return usually needs to exceed the expenditure for the investment to be considered profitable.

 This concept should be applied in the quality arena when preventive action is planned. Cost needs to be calculated, as does the expected benefit (return), to evaluate preventive action. Whenever process management with measurable outputs is used as a foundation for preventive action, the financial investment concept is easily applicable.

 Conversely, expense cannot always be linked directly to a measurable return. Corrective action will most often qualify as an expense--an expense caused by a lack of quality. Managers have learned from this comparison that preventive action is more beneficial to an organization than is corrective action. However, this common knowledge has not yet become common practice in many organizations.

Scope of quality

 Initially, most managers relate the term "quality" to their products or services. Quality exceeds this narrow scope by far. Proc-esses, and even systems, can also meet objectives or expectations. Only when an organization applies the quality concept to its processes and its entire management system will it be able to see an effect on its bottom line.

 If your organization has established a quality system, you probably maintain a list or log of corrective and preventive actions. Review this log and analyze what percentage of past improvement activities addressed individual products rather than processes or systems. To improve your organization's bottom line, improvement action must address processes and systems. Improvement action must focus on prevention of mistakes. Do the improvement activities in your organization fulfill these needs? Your management's team commitment to prevention principles determines your quality system's return on investment.

About the author

 Stefan Heinloth is president of DQS Inc., an accredited registrar that has registered more than 10,000 organizations worldwide. Heinloth is a certified lead auditor and has specialized in integrated management systems and effectiveness assessments. E-mail him at sheinloth@qualitydigest.com .