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Michael Mallen

Management

Cost of Quality: What Is It, and Why Is It Important?

Understanding the impact of cost of quality generally leads to better bottom-line performance

Published: Wednesday, April 7, 2021 - 11:03

The concept of cost of quality (COQ) has been around for decades, but applying it to business is difficult. The adage “quality is free” (coined by Philip B. Cosby in his book by the same title) does not simply mean that you don’t have to pay for it. It means that you are likely already paying to deliver “quality” to your customers.

What cost of quality isn’t

Quality used to be synonymous with “expensive” because higher-quality products typically cost more. Makes sense, right? For something to be “quality,” you must pay for premium materials, premium workmanship, and premium service. You can’t compare a Rolls Royce to a Ford Escort and not see the disparity in quality.

However, these days consumers expect value instead of quality. The difference between the two can be defined as the following:
Quality: The usefulness or worth of something
Value: The usefulness or worth of something relative to its price

Adding price to the discussion means we must now consider the cost involved to create the value. How a particular organization defines the cost of quality depends on the quality culture of the organization and the level of maturity of its quality management system. Some popular misconceptions regarding COQ include:
1. It’s the cost I have to pay to staff the quality department.
2. It’s the cost I have to pay to customers for chargebacks.
3. It’s the cost I have to pay for scrap.
4. It’s built into my pricing so I don’t have to worry about it.

Unfortunately, these are blinkered views of COQ, but they help to define how successful (or not) your organization will be. Businesses that understand the broader definition and impact of COQ generally have better bottom-line performance. Understanding that improved quality performance can directly affect financial indicators such as earnings before interest, taxes, depreciation, and amortization (EBITDA) is key. Business management, including quality management, must understand the financial implications their decisions have on the organization, both in the short and long terms. Leadership must have a clear understanding of the total cost of quality.

What is total cost of quality?

The total cost of quality can be broken down into four key areas:

Organizations generally feel that they have a great understanding of external and internal failures, but do they? Let’s take a look at each in a little more detail.

External failures
Undeniably the worst type of costs to the business, external failure costs include product recalls, warranty costs, field repairs, and premium freight charges. These are the costs that most organizations track and measure, but are there others?

Internal failures
Perhaps not as bad as external failure costs, internal failure costs are still costs that can impact your competitiveness. Generally tracked examples include scrap, rework, overtime, and premium freight (yes, it can be counted here as well). But is this the tip of the iceberg?

How about the other side of the coin—the cost of good quality? This area is not given the attention it deserves in most organizations. The cost of good quality can be broken into two categories, appraisal and prevention.

Appraisal
Some argue that these costs can be split between good and bad costs. Many companies see them as the cost of doing business. Appraisal costs include inspections and testing, calibration, and product qualification. The issue here is that these activities are after the fact. The product has been manufactured, and the company is simply checking to see if it is OK. (So if the test is destructive and the product turns out to be good, was it worth doing the test?) If a company doesn’t understand its appraisal system, is it checking the correct things? If a test has never uncovered a bad product, does it need to be done? Are there other costs that would fall into the appraisal area that haven’t been identified?

Prevention
This is where most companies do a poor job, and where the most gains can be achieved. Prevention affects the overall cost of quality in a variety of ways, including hard-to-quantify costs:
1. Error-proofing methods that ensure the product is right the first time
2. Failure mode and effects analysis (FMEA) that identifies and controls a problem before it occurs
3. Planning activities that allocate the right resources to perform the right tasks at the right time
4. Identification and documentation of best practices to perform work the correct way
5. Training that ensures employees understand the work before they are released to the job

These steps each reduce the costs of internal and external failures dramatically. If organizations focused more of their efforts here, would the investment be worthwhile? How would this impact your bottom-line performance?

Is that everything?

Unfortunately, that doesn't cover all of it. There are also hidden costs of quality in every organization. These can be quantifiable costs that are considered standard costs and are simply absorbed. Or they can be soft costs that are hard to quantify but have a major impact on the organization’s performance. These costs can also be attributed to each of the four types of quality costs, as can be seen in the table below.

How can we leverage this information?

Change must be sold first, and the art of selling anything requires an emotional connection with the buyer. Quality tends to focus on the savings gained from implementing an improvement rather than on preventing the losses that are occurring. Unfortunately, losses are more effective in delivering an emotional punch to the gut, compared to savings. Quality management professionals must reframe their argument and use the language of business, not quality, to sell change within an organization.

Let’s compare a request for change described in two ways, one based on the standard quality approach, and the other based on a margin-loss message.

Quality-speak: “I need to implement a failure mode and effects analysis system so I can improve process CpK to 1.66 and give you six sigma performance and save you money.”

Business-speak: “Our current loss-to-EBITDA is $12.2 million. We need to implement an FMEA system that will cost $200,000. We predicate a 10-percent year-on-year improvement following implementation of the system that will prevent a loss of $1.2 million. In addition, we predict an increase in available capacity by 15 percent, based on reduction in rework and scrap rate.”

Which one would you pick as an operations manager?

A call to action: Include accounting and IT

You don’t need to wage this campaign on your own. Accounting and IT are key stakeholders in this battle.

The general ledger holds a wealth of knowledge for uncovering the true cost of quality and can quickly generate some basic numbers. Investigate activity-based accounting to understand the actual costs of production and how they impact the performance of the organization.

The IT team can provide you with the systems and information you need to make your pitch for change. Upgrade to a state-of-the-art, cloud-based, enterprise-level quality management system (EQMS). Do your research and come to the IT team with a cloud-based EQMS that vertically integrates functionality within your system and seamlessly integrates with third-party software such as enterprise resource planning (or better yet, one that is part of an enterprise resource planning system) or product lifecycle management. Choose wisely, and look for solutions that focus on prevention and the impact on operations, not just compliance.

Good luck with your journey to become a truly effective manufacturing enterprise.

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About The Author

Michael Mallen’s picture

Michael Mallen

Michael Mallen is a Quality Management Expert at QAD where he brings 30 years of experience in manufacturing, engineering and the development and management of quality systems. In his current role, Mallen consults with organizations in several industry verticals including Automotive, Life Science and Food and Beverage to improve the effectiveness of their business processes and maximize the ROI from QAD software.  Mallen has a B.S. (Honors) degree in Textile Design and Technology from Huddersfield University. His accreditations include Lean Six Sigma Master Blackbelt, ASQ Certified Quality Manager, Lead Auditor / Internal Auditor.