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Joseph A. DeFeo

Quality Insider

Superior Quality Drives Profitability

Managers must understand the connection and act accordingly

Published: Wednesday, June 18, 2014 - 14:25

Superior quality goods and services will result in sustainable financial results because they are more salable than those of the competition. This universal principle continually drives revenue and maintains lower costs, leading to greater profitability. In this way, the strategic pursuit of superior quality transforms the business and creates a favorable culture of improvement.

Superior quality delivered to customers does not just happen. The business, specifically its leaders, must make it happen. Quality is the inevitable result when the organization sets the strategic direction with a relentless pursuit to be the best in its field. There is a problem with this goal, however. Today, many business leaders do not always see the connection between the definition of “quality” and their own “strategy.” Why? Because the language of quality is now embedded into the greater language of business, and the specific definitions can get fuzzy. For instance, many organizations say they do not “do” quality; they “do” lean or Six Sigma. Their managers fail to recognize that these are one and the same. It is okay for leaders to think this way, but quality professionals need to know the language of today’s leaders and help them become knowledgeable on the methods (if not the language) that drive better business results.

Quality effects revenue and cost

Quality has a big effect on costs. Some organizations want to simply reduce production costs while ignoring the cost of underperforming products or services. In this case, quality has come to mean freedom from troubles traceable to office errors, factory defects, field failures, and so on. When customers perceive a service or good to be of low quality, they usually refer to worse-than-expected errors, defects, failures, and response times, etc. To improve this type of quality, an organization must master quality improvement. Breakthrough improvement is often realized through lean Six Sigma, which offers a systematic method to reduce the number of such deficiencies or the “costs of poor quality” to create a greater level of quality and fewer costs related to it.

Quality also has a big effect on revenue. In this case, higher quality means delivery of those features that respond better to customer needs. Because customers value higher quality, sales revenue will increase; being the recognized quality leader in a given sector allows the company to offer (and get) premium prices.

Quality has a ripple effect across the entire organization as costs and revenue interact with one another. Goods or services with deficiencies not only will add to suppliers’ and customers’ costs, but also discourage repeat sales. Customers who are affected by field failures are, of course, less willing to buy again from the offending provider. In addition, such customers do not keep this information to themselves—they publicize it, affecting the decisions of other potential buyers, which naturally has a negative effect on revenues.

The effect of poor quality on organizational finances has been studied broadly. In contrast, study of the effect of quality on revenue has lagged. This imbalance is surprising, given that most top managers assign higher priority to increasing revenues than to reducing costs. This same imbalance presents an opportunity for improving organization economics through better understanding of the effect of quality on revenue.

Driving results

At the most senior levels of management and among board members, there is keen interest in financial metrics such as net income and share price. It is clear that relative levels of quality can greatly affect these metrics, but so do other variables such as market choices, pricing, and financial policy.

However, separating out the market benefits of managing for quality is feasible. In an article in the Oct. 17, 1993, issue of Businessweek titled “Betting to Win on the Baldie Winners,” companies that had won the Malcolm Baldrige National Quality Award up to that time were compared to companies in the Standard & Poor’s index of 500 stocks. The results were striking. Baldrige winners saw their share prices increase by an average of 89 percent, as compared to only 33 percent for the S&P 500 over the same period of time. This set of winners became known as the “Baldie Fund.”

The positive effect of great quality is also clear for organizations that are not measured by the performance of their asset values. Michael Levinson, city manager of Coral Springs, Florida, a 2007 Baldrige winner, explains: “People ask, ‘Why Baldrige?’ My answer is very simple: Triple A bond rating on Wall Street from all three ratings agencies, bringing capital projects in on time and within budget, a 96-percent business satisfaction rating, a 94-percent resident satisfaction rating, an overall quality rating of 95 percent, and an employee satisfaction rating of 97 percent... that’s why we’re involved with Baldrige.”

Insulation against market forces

What do you do when lightning strikes your organization’s industry—when revenues rapidly decline, banking and financial institutions pull back, and there’s a national workforce decline?

That was the situation facing KARLEE, a contract manufacturer of precision machining and sheet metal. In a recent article published by Blogrige: the official Baldrige blog, JoAnn Brumit, CEO of KARLEE, explained that the organization’s performance excellence journey started in 1989, when a customer told her about the Baldrige. Eleven years later, in 2000, KARLEE won the Baldrige Award.

However, the company soon needed to utilize the Baldrige Criteria as part of a turnaround strategy. KARLEE had its most profitable year in 2000, with $80 million in revenue. Up to that point, in its 20-year history of 30-percent average annual growth, KARLEE had never experienced a decline, never had a losing quarter, never needed investors as it grew from returned earnings, and never had a workforce reduction. However, in 2000, 90 percent of the company’s revenue came from the telecommunications industry.

That year, the telecom sector began to collapse. More than 20 companies went bankrupt in a wave capped off by the bankruptcy of WorldCom, the single largest such event in American history up to that time. As a result of what Brumit called “the telecom train wreck,” KARLEE saw their revenues shrivel to just $12 million.

The discipline of the Baldrige Criteria helped the company survive and bounce back in a marketplace that has only gotten more competitive. Outsourcing and the need to find, train, and retain a shrinking base of next-generation manufacturing workers are ongoing challenges and concerns.

Where do we go from here?

The 20th century can rightly be considered the “century of productivity,” however, the 21st century will be known as the “century of quality.” Today all organizations can attain superiority in quality. The methods, tools, and know-how exist. For the foreseeable future, all organizations in all industries must strive for perfection, and the ultimate arbiter of success or failure will be financial in nature. Quality has always driven positive financial results, and the connection between the two will only be amplified in the years and decades to come.

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About The Author

Joseph A. DeFeo’s picture

Joseph A. DeFeo

Joseph A. DeFeo is president and executive coach with Juran. He is recognized worldwide for his training and consulting expertise which enables organizations to achieve superior results. For additional information, visit www.juran.com.