Performance Improvement
H. James Harrington

The Real Cost of Poor Quality

Its impact on customers isn't reflected in company ledgers.

Two primary objectives of any quality system or improvement process are to increase customer satisfaction and decrease error-related costs. Fundamentally, both boil down to money: Organizations want to increase customer satisfaction in order to sell more products, which allows them to make greater profits. Keeping this in mind, it's easy to see the importance of that old quality tool known as quality costs. Not only are quality costs the language of management and the investment community, but they're also the best way to measure a quality system's success. Why is it, then, that so few organizations use this tool?

 During his years as the director of quality at GE's Schenectady Works, Armand V. Feigenbaum realized the importance of converting the terms "percent defective," "defects per unit," "scrap" and "return rates" into dollars. In 1943, his team developed "quality costs," a dollar-based reporting system. It pulled together all the costs of developing a quality system and inspecting products, as well as the costs incurred when a product fails to meet requirements.

 Feigenbaum's concept has been refined and expanded during the years. Quality costs initially included four elements: prevention costs, appraisal costs, internal defect costs and external defect costs. Unfortunately, the term "quality costs" harks back to 1950s thinking, when manufacturers believed that better quality products cost more to produce. Given the change in management attitude toward quality and the new dimensions that have been added to the original concept, the old term tends to misrepresent present-day quality theories. Instead, the term "poor-quality costs" seems more appropriate.

 Another change occurred when we realized that the most significant poor-quality cost occurred in support areas. As a result, the term "errors" replaced "defects" because, although the latter applies mainly to the manufacturing floor, "errors" applies to both management and production. Another realization that helped refine the basic concept was that investment in equipment used to measure, accept or control the product or services, plus the cost of the space the equipment occupied, made up "equipment poor-quality cost." This cost must be handled differently than the other elements because it can't be reported as a one-time expense but must instead be amortized across its life cycle.

 The poor-quality cost model was divided into three major categories:

  Controllable poor-quality cost. Management directly controls this cost to ensure that only customer-accepted products and services are delivered. It includes prevention and appraisal costs.

  Resulting poor-quality cost. This is made up of internal and external error rates and includes all company-incurred costs that result from errors. It's directly related to management decisions in the controllable poor-quality cost category.

  Equipment poor-quality cost. This cost is separate because of the unique way it must be reported to management.


 All three, collectively called "direct poor-quality cost," can be directly measured and reflected in an organization's cost structure.

 But, poor quality's impact on the customer isn't reflected in an organization's ledger but rather in the customer's wallet. Thus, to succeed in business today, we also must pay attention to "indirect poor-quality cost." This can run more than the total price of the service or product. It, too, is divided into three areas: customer-incurred poor-quality cost, customer-dissatisfaction poor-quality cost and loss-of-reputation poor-quality cost.

 Customer-incurred poor-quality cost occurs when an output fails to meet customer expectations. Typical customer-incurred poor-quality cost includes loss of productivity while equipment is down; travel costs and time spent to return defective merchandise, repair after the warranty period is over, and loss of productivity while the error is being defined and corrected.

 Customer-dissatisfaction poor-quality cost occurs when a customer buys a competing product, affecting future sales to people who the customer knows.

 The third area, loss-of-reputation poor-quality cost, is even more difficult to measure and predict. The costs it brings differ from customer-dissatisfaction cost in that they reflect the customer's attitude toward the company rather than an individual product line.

 How do we use information about indirect poor-quality cost? Some companies ignore it; others consider it only when they're making a change in their appraisal activities, and still others incorporate it into their poor-quality cost system. The degree to which it's implemented is highly dependent upon how important an organization considers its customers to be.

 To sum up, the following models reflect today's poor-quality cost methodologies:

  Direct poor-quality cost. This includes controllable poor-quality cost as well as prevention and appraisal costs.

  Indirect poor-quality cost. This includes customer-incurred poor-quality cost, customer-dissatisfaction poor-quality cost and loss-of-reputation poor-quality cost.

 E-mail me if you're using parts or all of the poor-quality cost methodology.


About the author

 H. James Harrington has more than 45 years of experience as a quality professional and is the author of 20 books.

E-mail him at jharrington@qualitydigest.com  . Visit his Web site at www.hjharrington.com . E-mail letters to the editor to letters@qualitydigest.com 

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