A Quality Cost Model to
Determine Optimal Policies for
Purchased Components
EDWARD D. ARNHEITER, RENSSELAER POLYTECHNIC INSTITUTE
RICHARD J. GIGLIO, UNIVERSITY OF MASSACHUSETTS
This study develops a technique for predicting pur-
chasing quality costs and studying their behavior as
random variables. The resulting model extends prior
research that treats purchasing costs deterministically
or not at all, thereby providing a valuable decision
and planning tool for companies that are placing an
increasing reliance on purchased components. The
model was tested in the field at a small defense con-
tractor. Test results suggest that purchasing costs can
be reduced by using the model to select the lowest cost
policy from a set of three alternatives.
Key words: purchasing quality costs, random vari-
ables, simulation
54 QMJ 98 5, NO. 3/© 1998, ASQ
© 1998, ASQ
INTRODUCTION
In the literature, the term quality costs refers to costs
incurred when: recovering from or repairing a defect
(failure costs); detecting defects (appraisal costs);
and avoiding defects (prevention costs). Prevention
and appraisal costs are discretionary because the
amount to be spent in each category can be predeter-
mined and budgeted. Failure costs are called conse-
quential because their levels are a result of how much
the organization chooses to spend on appraisal and
prevention. An understanding of these costs has
strongly influenced manufacturing policies: for exam-
ple, placing a greater emphasis on prevention so as to
avoid failure and detection costs (Hsiang and Lee
1985; Juran and Gryna 1993; Godfrey and Pasewark
1988). Quality costs occur both in parts that are pur-
chased and those that are manufactured onsite. The
American Society for Quality (ASQ) has adopted the
above terminology, and it has become the internation-
ally accepted framework for discussing quality costs.
Specific elements of each of these costs are suggested
by Campanella (1990) and Riahi-Belkaoui (1993).
The trend in many industries is to purchase a larg-
er proportion of components, rather than manufacture
them inhouse. Because of this increased reliance on
purchased components, the study of purchasing quali-
ty costs becomes correspondingly important. There is
relatively little literature related to purchasing quality
costs. Therefore, this study develops mathematical
expressions for purchasing failure costs and purchas-
ing appraisal costs for several different policy alterna-
tives. Corrective action costs are also included in the
model in order to capture one element of purchasing
 A Quality Cost Model to Determine Optimal Policies for Purchased Components
prevention. Other purchasing prevention costs such as
supplier surveys, rating systems, and supplier quality
planning are more difficult to quantify and are not
considered in this paper.
Important quality cost inputs are treated as random
variables, with probability distributions estimated from
historical data wherever possible. This model, called the
purchasing quality cost (PQC) model, explicitly consid-
ers inspection, and is particularly applicable to products
used in critical applications where safety of the end user
is the primary concern. In these situations some form of
product inspection will always be appropriate.
EXISTING QUALITY COST
MODELS
For years, the common notion of quality cost behavior
has been described by the prevention-appraisal-failure
(PAF) model, which assumes that product perfection is
not possible. Therefore, the best business strategy is to
seek an optimal balance between discretionary costs
(prevention plus appraisal) and consequential costs
(internal and external failures) that minimizes the
total quality costs. Over the past two decades, leaders in
the field of quality have demonstrated that in many
instances it is possible to reach perfection at a finite
cost (Juran 1986), and a model that supports this
notion of achievable perfection has been developed.
The PQC model was developed for purchasing
quality costs, but the techniques discussed here
could certainly be used to develop models that
include additional quality costs.
The traditional and the emerging models illustrate
the theoretical quality levels that minimize total quali-
ty costs. They represent opposing viewpoints about
which quality level (based on conformance) is opti-
mal. Neither model, however, is of much use to the
quality practitioner trying to actually plan spending
levels that minimize total quality costs. To that end
management decision tools, designed to aid with qual-
ity cost planning, have also been developed.
One classic approach is the Deming k1, k2 model
(1982), which demonstrates that an all-or-nothing
policy toward inspection is always less expensive than
acceptance sampling, provided that the process is sta-
ble and under statistical control. Juran and Gryna
(1993) take a similar approach, except they assume
the cost to replace a defective item found at inspection
is borne by the producer, or is small compared to the
damage or inconvenience caused by the defective item.
Therefore, their model assumes no replacement of
nonconforming units and ignores scrap or rework costs
associated with rejected lots. As in the Deming model,
the expected cost of each alternative relies on an esti-
mate for the probability of acceptance and rejection of
the lot. Case, Schmidt, and Bennett (1972) provide an
expression for the expected cost of acceptance sam-
pling similar to the sampling cost expression given in
the Juran and Gryna model, with two important excep-
tions. First, Case, Schmidt, and Bennett assume that it
is uneconomical to sort rejected lots, so instead they
are scrapped completely. In addition, the proportion of
nonconforming product in the lot (p) is treated as a
random variable, with the frequency distribution deter-
mined from empirical data.
Godfrey and Pasewark (1988) consider opportunity
costs, long-term market effects, and relationships
among costs that affect total quality costs.
Krishnamoorithi (1986) investigates the quantitative
relationship among the four components of quality
cost by using data from 23 quality systems, taken pri-
marily from published literature. Using nonlinear
regression analysis, Krishnamoorithi develops expres-
sions for internal and external failure as functions of
prevention and appraisal. These functions are used to
assist with quality investment decisions and to justify
improvement projects.
Freeman (1995) combines the cost of quality
(COQ) concept with the Taguchi loss function in a
large-scale Monte Carlo simulation. The purpose of his
model is to show which manufacturing process has the
most potential for quality cost savings, and to provide a
structured method for measuring the effect of reducing
process variability. Using data from an actual manu-
facturing firm as an example, the simulation suggests
that by introducing a new test station and reducing the
E. D. ARNHEITER, R. J. GIGLIO/© 1998, ASQ 55
 A Quality Cost Model to Determine Optimal Policies for Purchased Components

Table 1 Summary of existing quantitative models.

Author Basic approach and features What the model estimates Quality costs included

Case, Schmidt, Utilizes Pa . Treats the lot Expected cost of (n, c ) • Inspection cost
and Bennett proportion defective (p) as sampling. • Scrap cost (all rejected lots are scrapped)
(1972) a random variable. • Damage cost

Deming Utilizes Pa in (n, c ) sampling Expected cost of • Inspection cost

(1982) cost expression. Includes cost • (n, c ) sampling • Cost to disassemble and reassemble a
to find good replacements. • No inspection bad assembly (combination of internal
• 100% inspection and external failure costs)

Krishnamoorithi Uses nonlinear regression to Total quality costs as a Aggregate values for
(1986) develop expressions for internal percent of sales. • Appraisal
and external failure as functions • Internal and external failure
of prevention and appraisal. • Prevention

Godfrey and Uses historical cost data and
Pasewark focuses on relationships
(1988) between the cost categories.
No probability used.
Total quality costs
• Rework
• Lost profit
• Processing customer returns
• Cost of lost sales
• Prevention and appraisal (lumped as
defect control costs)

Juran and Gryna Utilizes Pa in (n, c ) sampling Expected cost of • Inspection cost
(1993) cost expression. Ignores cost to • (n, c ) sampling • Damage cost if bad item slips through
find good replacements, and • No inspection inspection
scrap or rework associated with • Inspection
rejected lots. Includes cost to
sort rejected lots.

Freeman Simulates losses due to departures
(1995) from target dimension using TLF
and adds expected costs of
inspection and warranty. Includes
inspection of reworked units,
Total of Taguchi loss
function, warranty costs,
and all costs associated
with either (n, c ) sampling
or 100% inspection.
• Loss to society (using TLF)
• Inspection cost
• Warranty cost
• Scrap and rework cost
• Cost of production lost when process

© 1998, ASQ
and cost to find good needs adjusting
replacements. • Cost of process adjustment

variation of an operation, a reduction in the overall
quality cost per unit could be realized.
A summary of the basic approach and assumptions
of each quantitative quality cost model, along with the
nature of the estimates generated, is shown in Table 1.
THE PQC MODEL
The review of the existing COQ literature highlights
some deficiencies. First, although numerous theoreti-
cal quality cost models have been developed, there is a
shortage of research demonstrating their application
using empirical data. In addition, no one has focused
on the nature of purchasing quality costs, despite their
impact on modern supply chain management prac-
tices. In contrast, the PQC model captures quality costs
uniquely associated with purchased components, such
as shipping and travel costs.
None of the existing quantitative models treats
quality costs as random variables. Case, Schmidt, and
Bennett (1972) treat the proportion nonconforming
(p) as a random variable, but consider cost parameters
to be deterministic. Freeman (1995) only incorporates
randomness in the value of the quality characteristic
itself (for example, hole diameter). The PQC model
treats purchasing quality costs as random variables
and realistically captures many of the major purchas-
ing quality cost elements. The model considers the
expected cost of three alternative policies.
1. Incoming evaluation of components
2. Evaluation of components at the supplier
3. Waiving of product evaluation with a review of sup-
plier data only
The cost of off-site evaluation (at the supplier), as an
alternative to incoming evaluation, has not been

56 QMJ 98 5, NO. 3/© 1998, ASQ

 A Quality Cost Model to Determine Optimal Policies for Purchased Components

Table 2 How parameters of PQC model relate to purchasing quality cost elements.
Purchasing quality cost element Symbol Description of included cost

Purchasing prevention costs

Corrective action Ca • Failure analysis and investigations into the cause of

supplier rejects

Purchasing appraisal costs

Incoming evaluation and tests k • Unit inspection cost

Source evaluation and control programs T • Travel costs to supplier
Cd • Cost to review supplier data
k • Unit inspection cost
Measurement equipment • Not in model
Qualification of supplier product • Not in model

Purchasing failure costs

Purchased material reject disposition M • Dispositioning costs

Costs S • Scrap costs
Purchased material replacement costs s • Shipping costs to return parts (when not paid for by supplier)

© 1998, ASQ
Rework of supplier rejects ra • Unit rework cost at assembly
Uncontrolled material losses • Not in model

considered in previous literature. The cost parameters
used in the PQC model relate to the major cost
elements of the purchasing quality cost classification
system, as shown in Table 2.
Primary Assumptions of the
Lots rejected during incoming evaluation have
two possible routings depending on their production
priority. When parts are not urgently needed, the
model will include the expected shipping cost to
return the lot to the supplier. When parts are required
to fill immediate production needs, the model

PQC Model includes the expected in-house sorting costs. In addi-

As with all quantitative models, important assumptions
were required to develop the PQC model. These
assumptions can be summarized as follows:
• No inspector error exists.
• Acceptance sampling is by attributes.
• Lots rejected during source evaluation are reworked
or replaced by suppliers.
• A source examiner typically selects a smaller sample
than the customer’s incoming department.
• Nonconforming components not caught by incom-
ing or source evaluation will usually be discovered
at assembly or test.
• At assembly, nonconforming components are either
reworked, scrapped, or used as is; that is, they are
not sent back to the supplier.
• No provision is made for the cost of finding good
replacements.
tion, it is assumed that if a system fails in the field it
is most likely due to deficiencies caused at assembly,
or by a poor design, not because of defective pur-
chased components. This is certainly not always the
case, but it is a realistic assumption for many defense
companies and others who perform numerous tests
on all subassemblies as well as the final system prior
to releasing it to the customer.
Expressions for the expected cost of incoming eval-
uation (EC I ), expected cost of source evaluation
(ECS ), and the expected cost of waiving evaluation in
favor of data review (ECW ) were developed. The PQC
model is shown in Table 3. It provides expressions for
expected costs, as well as summaries of the notation
used and the primary assumptions of each expression.
The PQC model was developed for purchasing quality
costs, but the techniques discussed here could certainly
be used to develop models that include additional
quality costs. Mathematical details of the model devel-
opment are given in the appendix.

E. D. ARNHEITER, R. J. GIGLIO/© 1998, ASQ 57

 A Quality Cost Model to Determine Optimal Policies for Purchased Components

Table 3 Expressions for expected costs as defined in the PQC model.

Approach Expected cost expression Notation Assumptions

Sampling Using incoming evaluation:
nI k  [(N  nI) (pr ra  ps S) 
M]p Pa I  (1  Pa I [(1  F)(s) 
(Ca  M)  Fk (N  nI)]
Using source evaluation:
ns k  [(N  ns) (pr ra  ps S) 
M]p Pas  Cd (nI  ns)  (T/L)
(for nI  ns)
Ca
cost of corrective action (per lot)
Cd
unit cost to review supplier data
F
production priority factor (0 or 1)
k
unit cost of inspection
L
number of lots evaluated during visit
M
disposition costs (per lot)
pr
probability component can be reworked
ps
probability component needs scrapping
ra
unit cost to rework at assembly
s
shipping costs to return lot to supplier
S
unit cost to scrap component
T
travel costs to supplier
Bad units found at supplier are
reworked or replaced by supplier,
at no cost to customer. Bad units
caught at incoming are either
sorted by customer or returned to
vendor. Bad units making it to
assembly are either reworked,
scrapped, or used as is. No
provision for finding good
replacements.

Waiving nd
size of supplier data review Bad units found at assembly are
product Cd
unit cost of data review either reworked, scrapped, or
evaluation p [N (pr ra  ps S)  M]  pr
proportion of time we can rework used as is. Even though we do
Cd nd ps
proportion of time we must scrap unit not inspect the units, we still
ra
unit cost to rework at assembly review vendor data.

© 1998, ASQ
S
unit scrap costs
M
disposition costs (per lot)

Table 4 Rules used when selecting input probability distributions for the PQC model.
Probability distribution (@RISK PQC model
functions shown in all caps) Applications Data type parameters

BETASUBJ (minimum, most likely, A heuristic procedure for rough modeling when Continuous p
mean, maximum) actual data are absent. Real-world data indicate that
density functions corresponding to time to complete
Note: a task often have this shape, skewed to the right.
Most likely = mode Also useful for distribution of a random proportion
such as proportion of defective items in a shipment.

DISCRETE ({x1,...xn},{p1,...pn}) For situations with a discrete number of outcomes. Discrete F, L, N, M

For each possible x value, an empirical mass function
p(x) is defined by specifying the proportion of Xi s
equal to x.

HISTOGRM (minimum, maximum, Distribution for grouped data, approximation of Continuous k, ra

{p1,...pn}) arbitrary probability distribution, graphic
approximation of a distribution.

TRIANG (minimum, most likely, Used as a rough model in the absence of data Continuous Cd, S, s
maximum) (heuristic procedure).

Dependency Parameters that have dependency relationships Continuous nI (depends on N)

with other parameters. or discrete n d (
n I)
ns (
70% of nI)
c (0 to 1, depends on nI)

Deterministic For parameters whose values are known, or are Continuous T, Ca , pr , ps

© 1998, ASQ

assumed to be some fixed value. Values often or discrete

depend on which supplier is being analyzed.

58 QMJ 98 5, NO. 3/© 1998, ASQ

 A Quality Cost Model to Determine Optimal Policies for Purchased Components

SUMMARY OF PROBABILITY utilizing only a few simple distributions for parameter

FUNCTIONS USED IN THE
SIMULATION
One of the drawbacks with even relatively simple quan-
titative models is that, in practice, the values of the
model parameters are frequently difficult to estimate.
For this reason a “rule-of-thumb” was developed,
estimation. Simple probability distribution functions
are often very powerful because uncertainty in the
model can be described with only a few values or argu-
ments.
The input distributions used in the PQC model are
summarized in Table 4. Each parameter in the model
is listed in the right-hand column, in the row corre-
sponding to the approach used for estimating.

Figure 1 The PQC spreadsheet model with @RISK distributions shown.

A B C D E F G
1

5 Parameter estimates used

Symbol Costs are for supplier code B
6 Minimum Most likely Mean Maximum

7 N RiskDiscrete (N!I6:I41,N!J6:J41)

8 ns VLOOKUP (C7,ns!B8:E30,4)

9 nI VLOOKUP (C7,nI!B5:C27,2)

10 nv C9

11 c IF (C9 
13,1,0)

12 L RiskDiscrete (L!I6:I16,L!J6:J16)

13 p RiskBetaSubj (D13,E13,F13,G13) 0.02 0.025 0.03 0.05

14 pr 0.300

15 ps 0.100

16 F RiskDiscrete ({0,1},{0.3,0.7})

17 Cd RiskTriang (D17,E17,G17) 15 16 20

18 M RiskDiscrete ({100,160},{0.4,0.6})

19 s RiskTriang (D19,E19,G19) 22 41 59

20 Ca $100

21 ra RiskHistogrm (ra!B7,ra!C7,ra!D7:S7)

22 T $50

23 k RiskHistogrm (k!B7,k!C7,k!D7:O7)

24 S RiskTriang (D24,E24,G24) $ 10 $ 100 $ 1000

25 EC I C9 * C23  ((C7C9) * (C14 * C21  C15 * C24)  C18) * C13 * BINOMDIST (C11,C9,C13,TRUE) 
(1BINOMDIST (C11,C9,C13,TRUE)) * ((1C16) * C19  (C20  100)  C16 * C23 * (C7C9))

26 EC s C8 * C23  ((C7C8) * (C14 * C21  C15 * C24)  C18) * C13 * BINOMDIST (C11,C8,C13,TRUE )
© 1998, ASQ

C17 * (C9 C8)  (C22/C12)

27 EC w (C7 * (C14 * C21  C15 * C24)  C18) * C13  (C17 * C10)

E. D. ARNHEITER, R. J. GIGLIO/© 1998, ASQ 59

 A Quality Cost Model to Determine Optimal Policies for Purchased Components

Empirical distributions were used whenever actual
data were available. When data were lacking, but sub-
jective estimates of the minimum, mode, mean, and
maximum could be gathered, then either the beta or
triangular distribution functions were used.
Sufficient iterations are performed to develop probabili-
ty distributions of the costs.
Figure 1 shows the PQC model as it was incorporated
within an Excel spreadsheet. The actual cell contents are
displayed so that the reader may see how the @RISK
probability distribution functions were integrated.

SIMULATING THE PQC MODEL

The PQC model is incorporated into an Excel spread-
sheet, which serves as a platform for running the simu-
lation and sensitivity analysis. Cells designated for
input parameters contain three different types of
entries: (1) constants if the parameters were treated
deterministically; (2) probability distributions if the
parameters were handled stochastically; or (3) refer-
ences to other cells if there was a dependency relation-
ship between variables. Simulations were conducted
using @RISK (Palisade Corporation 1996), which pro-
vides a tool for introducing random variables within
the Excel framework, an environment with which most
users are familiar. For parameters that are random
variables, @RISK selects sets of values from the user-
specified probability distribution functions, and the
worksheet is then recalculated using the new values.
Results of the Simulation
Results of the simulation for several selected suppliers of
Acme Company are shown in Table 5. (Note: the name
of the company has been disguised at its request.) For
each supplier, 1000 iterations of the PQC model were
performed with a total run time of three to four minutes,
utilizing a 486 DX-33 system with 16 MB of RAM.
During the simulation analysis it became apparent these
were the minimum system requirements for running
such a complex model with the @RISK program.
Histograms of the results show the vast majority of
the simulated cost values falling within a fairly narrow
window. For example, for supplier B, 64 percent of the
incoming evaluation expected costs and 51 percent of
the source evaluation expected costs were less than
$50, while 77 percent of the costs associated with the

Table 5 Simulation results for 1000 iterations of the PQC model.

Supplier A Supplier B Supplier C
Std. Std. Std.
Min. Mean Max. Dev. Min. Mean Max. Dev. Min. Mean Max. Dev.
ECI $1 $ 102 $ 1275 151.82 $3 $ 58 $ 828 72.69 $ 13 $ 62 $ 176 28.62

ECs $6 $ 94 $ 776 98.15 $6 $ 61 $ 627 52.84 $ 144 $ 453 $ 813 254.92

ECw $8 $ 37 $ 129 27.05 $4 $ 20 $ 264 22.03 $ 35 $ 46 $ 64 4.59

N 1 10.73 39 9.39 1 5.37 84 8.85 3 3.67 5 0.769

L 1 3.82 16 3.90 1 4.45 12 3.32 1 2.75 6 1.80

p 0.001 0.015 0.025 0.006 0.000 0.015 0.025 0.006 0.020 0.030 0.049 0.006

F 0 0.72 1 0.449 0 0.68 1 0.466 0 0.71 1 0.456

Cd $ 5.08 $ 7.40 $ 9.96 1.042 $ 3.09 $ 5.00 $ 6.82 0.796 $ 15.13 $ 17.07 $ 19.87 1.10

M $ 100 $ 136 $ 160 29.43 $ 100 $ 136 $ 160 29.41 $ 100 $ 136 $ 160 29.32

s $23.17 $ 40.96 $ 58.58 7.63 $ 23.27 $ 40.81 $ 58.51 7.49 $ 23.10 $ 40.67 $ 58.41 7.49

ra $ 0.00 $ 17.52 $ 64.81 15.35 $ 0.01 $ 21.79 $ 92.89 18.40 $ 0.03 $ 22.01 $ 79.60 18.32
© 1998, ASQ

k $ 0.00 $ 21.49 $ 119.89 26.00 $ 0.02 $ 20.44 $ 99.50 21.29 $ 0.13 $ 20.53 $ 73.99 13.81

S $ 131 $ 602 $ 1165 219.35 $ 238 $ 811 $ 1468 265.75 $ 115 $ 601 $ 1192 228.91

60 QMJ 98 5, NO. 3/© 1998, ASQ

 A Quality Cost Model to Determine Optimal Policies for Purchased Components

waiver policy were less than $20 (see Figures 2, 3, and determining expected costs in the PQC model. Any
4). This knowledge would likely convince manage- sensitivity study has two aspects.
ment to consider doing less component inspection in 1. What is the rate of change of the variables with
favor of a thorough supplier data review. Similar respect to the output?
results were found for suppliers A and C. The stipula-
2. How statistically significant are these rates of
tion that nonconforming components are caught at
change?
assembly or systems test, and, therefore, should not
reach the hands of the customer, makes the waiver Figure 3 Histogram for ECs (supplier B).
policy even more attractive.
After examining additional suppliers using the PQC Expected cost of source evaluation
model, Acme reached three important conclusions 4000

regarding its purchased parts programs. First, to make

327
source evaluation more cost competitive, the company
300
would need to sharply increase the number of lots
246
checked during trips to nonlocal suppliers. Second, for

Frequency
local suppliers with poor quality, source evaluation is 200 180
the lowest cost alternative. The third conclusion Acme 139
drew from the simulation is that for local suppliers
100
with better quality (that is, average p = .015), waiving
42
component evaluation in favor of a supplier data 24
review is the optimal policy. 0
0.

50

10

15

20

25

30

35
0–

.0

0.

0.

0.

0.

0.

0.
25

0–

0–

0–

0–

0–

0–
–7

SENSITIVITY ANALYSIS
5.
.0

17

27

37
22
12

32
0

5.

5.

5.
5.
5.

5.
0

0
0
0

© 1998, ASQ
Standard deviation = 52.86
Sensitivity analysis was used to identify the input Mean = 60.9
N = 1000.00
distributions that are significant or critical inputs for

Figure 2 Histogram for ECI (supplier B). Figure 4 Histogram for ECw (supplier B).

Expected cost of incoming evaluation policy Expected cost of waiving product evaluation
4000 600
357 533
5000

300 283
400
Frequency

Frequency

200 300
141 233
200
100
69 114
41 33 100
24
36
0
0
0.

50

10

15 125

20

25 225

30

35 325
0–

0.

20

40

60

80

10

12

14 130
.0

0.

0.

0. 5.0

0.

0. 5.0

0.
25

0–
0–

0– 0

0–

0– 0

0–

0– 0
–

.0

.0

.0

.0

0.

0. 0.0

0.
75

10
.0

37

0–

0–

0– 0
–3

–
–5
.0

70
7

90
0.
.0

11

15
5.

0.

.0

.0
.
.

0
0

0.
© 1998, ASQ

Standard deviation = 72.73

© 1998, ASQ

Standard deviation = 22.04

Mean = 58.0
Mean = 20.1
N = 1000.00
N = 1000.00

E. D. ARNHEITER, R. J. GIGLIO/© 1998, ASQ 61

 A Quality Cost Model to Determine Optimal Policies for Purchased Components

To address the first aspect of sensitivity analysis, Table 7 Simulation sensitivities by supplier.
@RISK includes multivariate stepwise regression rou-
Normalized regression coefficients
tines that enable the determination of the relative
effect of model parameters on cost. In the case of the Parameter Supplier A Supplier B Supplier C

PQC model, this procedure is essentially being used to ECI N 0.4714 0.5747 0.0721
k 0.6762 0.6535 0.9966
identify critical input variables. The idea is that once p 0.0974 0.0869 0.1453
these critical variables are identified, they can become S 0.0000 0.0345 0.0366
the focus of attention when using the PQC model for ra 0.0000 0.0000 0.0111
F 0.0402 0.0000 – 0.0084
planning purposes. M 0.0000 0.0000 0.0285
The second question implies that when interpreting s 0.0000 0.0000 0.0041
the simulation results it is first necessary to validate the ECs N 0.4900 0.6022 0.0000
model and the sensitivity study. The method used here k 0.6223 0.5540 0.0395
S 0.0000 0.0642 0.0000
was to look at the regression R2 values. Any values L – 0.1577 – 0.2542 – 0.8895
below 0.60 represent unstable reported sensitivity statis- ra 0.0000 0.0000 0.0000
p 0.0708 0.0591 0.0000
tics, in which case running the simulation again with M 0.0000 0.0000 0.0000
the same model could yield a different ordering of Cd 0.0000 0.0000 0.0000
input sensitivities. Table 6 contains the R2 values for ECw N 0.9344 0.9175 0.3375
three of Acme’s key suppliers. Since these values are all S 0.1245 0.1118 0.5472
p 0.1727 0.1566 0.5117
relatively large (most are above 0.7), the regression Cd 0.1412 0.0871 0.4858

© 1998, ASQ
coefficients can be used as measures of sensitivity. ra 0.0000 0.0231 0.1329
M 0.0290 0.0000 0.1948
Table 6 Coefficients of multiple determination (R2)
for the PQC model.
The expected cost of waiving inspection (EC W )
Output exhibits more variability between suppliers in terms of
Source Expected cost critical parameters. Lot size (N) is one of the three
Incoming evaluation of waiving
Supplier expected expected component most significant inputs for all suppliers except supplier
costs costs evaluation C. This is likely due to the fact that N for supplier C has
A .69565 .67042 .91719 a standard deviation of only 0.769. This is the smallest
value of all three suppliers. In general, the Acme lot
© 1998, ASQ

B .74446 .73435 .89532

C .99826 .79544 .96524
Summary results of the normalized regression coef-
ficients for all three suppliers are shown in Table 7.
Here, the top three critical parameters are shown in
bold type. As an example of sensitivity analysis for sup-
plier B, parameter k had the largest impact on the
value of incoming expected costs with a sensitivity of
0.6535; N had the second largest impact at 0.5747; and
so on. This can be interpreted to mean that an increase
of 0.6535 standard deviation of k, leads to +0.6535
standard deviation change in the output (that is,
incoming expected costs in this case). For incoming
expected costs the dominant parameters (ECI ) are N,
k, and p. For source evaluation (ECS ), the critical
parameters are N, k, and L.
size data exhibit large variability, which increases vari-
ability of the model output, and is a contributing factor
to the critical nature of parameter N. Parameter p is
critical for all suppliers, which intuitively makes sense
in this case because product evaluation is being waived
and expected costs are, therefore, largely influenced by
the probability that the lot contains a nonconforming
component. The third critical variable differs by suppli-
er, with either S or Cd winning out.
The results of a sensitivity analysis can also be
graphically summarized using a tornado graph, such
as the type shown in Figure 5. This chart shows the
coefficient values for regression sensitivities associated
with supplier B, using the source evaluation output
variable. The length of the bars for each input parame-
ter is proportional to the calculated coefficient values.

62 QMJ 98 5, NO. 3/© 1998, ASQ

 A Quality Cost Model to Determine Optimal Policies for Purchased Components

Figure 5 Regression coefficients for supplier B (ECs ).

APPENDIX: MATHEMATICAL
Regression sensitivity for ECs
N (.602)
DETAILS OF THE PQC MODEL
Much of the notation needed to develop the PQC model
k (.554) is given in Table 3. Additional parameters not explicitly
L (–.254) defined there are as follows:
S (.064)

© 1998, ASQ
Number of items in the source evaluation sample
ns
p (.059)
Number of items in the incoming evaluation sample
nI
Number of items for which supplier data are reviewed
nd
–0.4 –0.2 0 0.2 0.4 0.6 0.8 1.0 Acceptance number
c
Probability that lot will be accepted by the source
Standard b coefficient
sampling plan
Pas
Probability that lot will be accepted by the incoming
sampling plan
PaI
CONCLUSION Also define a production priority factor (F) such that:

A model that explicitly represents purchasing quality
costs and the probabilistic nature of cost elements has
been shown to be useful in guiding decisions regarding
a company’s program for purchasing parts. When
computer simulation is combined with a quantitative
model for purchasing quality costs, it becomes possible
to realistically compare the cost of alternative appraisal
policies regarding choice of suppliers, inspection poli-

0 If there is time to send the rejected
F = lot back to the supplier
1 If there is no time to send the rejected
lot back to the supplier
By combining the inspection cost, acceptance cost, and
rejection cost, an expression for the total expected cost when
performing incoming evaluations (ECI) can be developed.
ECI
nI k  [(N  nI)(pr ra  ps S)  M] p 




cies, and supplier evaluation visits. This technique will

Appr. Purchasing failure cost
undoubtedly lead to more accuracy and confidence Cost incurred if we accept a lot
with the economic decision-making process. with p proportion defective.
The equations and framework developed in this
(1  F)(1  PaI)s  (1  PaI)(Ca  M)  Fk(N  nI)(1  PaI)
paper are valid for general use, providing the primary





assumptions of the PQC model are met. The actual We incur shipping We will always When F
1, parts
results of the simulation, however, will depend on com- only when F
0. have disposition must be sorted by
and corrective the customer.
pany cost data, values for other model parameters, and action.




the selected probability distributions. For example, at

Acme, local suppliers with poor quality were found to be Purchasing failure cost incurred if we reject the lot
best managed with source evaluation. This may not be (rejection cost).

the case with another company, but the objective would
remain the same: to find the best component supplier
based on total expected purchasing quality costs.

nI k  [(N  nI) (pr ra  ps S)  M] p PaI 
(1  PaI)[(1  F)(s)  (Ca  M)  Fk(N  nI)]
By expressing the probability of acceptance (Pi) using the bino-
mial cumulative distribution function, which gives the probability
of finding c or fewer nonconforming units in a sample of size n
with input quality p, the equation for ECI becomes:
c
ECI
nI k  [(N  nI)(pr ra  ps S)  M] p

y
0
b(y;nI, p) 

c
[1 
y
0
b(y;nI,p)][(1  F)(s)  (Ca  M)  Fk(N  nI)]

E. D. ARNHEITER, R. J. GIGLIO/© 1998, ASQ 63

 A Quality Cost Model to Determine Optimal Policies for Purchased Components

Similarly, the complete expression for the expected cost of BIOGRAPHIES

source evaluation can be given as:
ECS
ns k[(Nns)(pr raps S)M] p PasCd (nIns)(T / L)
c 11 years in industry as an operations management practitioner,

ns k  [(N  ns)(pr ra  ps S)  M] p 
y
0
b(y;ns,p) 
Cd (nI  ns)  (T / L)
The expected cost of the waiver policy can be expressed as:
ECW
p[N (pr ra  ps S)  M]  Cd nd
REFERENCES
Campanella, J., ed., and the ASQC Quality Costs Committee.
1990. Principles of quality costs. Milwaukee: ASQC Quality
Press.
Edward D. Arnheiter is an assistant professor in the Lally School
of Management and Technology at Rensselaer Polytechnic
Institute. Prior to beginning his academic career, Arnheiter spent
in both the defense sector and in consumer products manufactur-
ing. He held managerial positions with several major companies
including General Electric Defense Systems, Spalding Sports
Worldwide, and Titleist and Foot-Joy Worldwide.
Arnheiter has taught numerous courses in advanced quality man-
agement, managerial statistics, and manufacturing systems man-
agement. He received a doctorate in industrial engineering and
operations research from the University of Massachusetts at
Amherst. He may be contacted at the Lally School of
Management and Technology, Rensselaer at Hartford, 275
Windsor Street, Hartford, CT 06120-2991; 860-548-2430; Fax:
860-547-0866; E-mail: arnheite@rh.edu .

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experience in those fields, including full-time employment as a
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founded the first video-based master of science program in engi-
neering management to serve working engineers and managers,
and directed that program for 15 years.
Giglio earned a Ph.D. in industrial engineering from Stanford
University. He may be contacted as follows: Mechanical and
Industrial Engineering Department, University of Massachusetts
at Amherst, Amherst, MA 01002; 413-545-0646; Fax: 413-
545-1027; E-mail: giglio@ecs.umass.edu .

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Riahi-Belkaoui, A. 1993. Quality and control — An accounting

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64 QMJ 98 5, NO. 3/© 1998, ASQ