IE 475

Advanced Manufacturing Costing Techniques

Lecture Notes #6

Cost of Quality

Learning Objectives

After completing this module, IE 475 students should be able to:

Understand the strategic importance of quality Understand the differences between the two types of conformance Understand the four major categories of quality costs

Introduction

Prior to 1950 there was very little tracking of quality costs Much of the costs appeared in overhead categories Since then, quality costs have been steadily rising and they can be significant Costs of Quality (CoQ) are associated solely with defective product

Making, finding, repairing and avoiding

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Hidden Costs of Poor Quality

Reprocessing Customer Returns

Rejects

Sorting Inspection

Warranty Expenses

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Adapted from Juran, J.M., Gyrna F.M. (1993), Quality Planning and Analysis, Third Edition, McGraw-Hill, Inc., New York

Cost Management Paradigms

Traditional Cost Management Normal allowance for scrap and rework Overhead variance analysis encourages maximum production quantity not quality Financial measures only Strategic Cost Management

Cost Management Paradigms (cont.)

Traditional Cost Management Strategic Cost Management

No tracking of customer acceptance

No COQ analysis Top tier of reference group

Meet standards

Why is Quality important?

Quality Products & Services Increased Business Volume

Greater customer satisfaction

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Conceptual Linkage between Quality and Profitability

Product quality and profitability are closely related Businesses that offer premium-quality products and services are more likely to have large market shares Quality relates positively to a higher return on investment

Conceptual Linkage between Quality and Profitability (cont.)

Investments in Quality Improved Quality Lower Return Sales Lower Inventory Lower Mfg Cost Higher Perceived Value More Satisfied Customers Faster Throughput Time

Lower Warranty and Service Costs

Higher Turnover

Higher Prices

Higher Market Share

Faster Delivery

Increased Revenues

Financial Performance

Types of Quality Conformance

Quality involves conformance with specifications for products or services that meet or exceed customer requirements and expectations Conformance, however, can differ among individuals or firms Types of Quality Conformance

Goalpost Absolute

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Types of Quality Conformance Goalpost Conformance

Conformance to a quality specification expressed as a specified range around the target

Target is the ideal or desirable outcome of the operation

Goalpost conformance assumes that the firm incurs no quality or failure cost or loss if quality measures fall within the specified limits

Considered a zero-defect conformance

Loss
Lower Limit .45

No Loss
Target Value .50

Loss
Upper Limit .55

Thickness
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Types of Quality Conformance Absolute Conformance

Absolute quality conformance requires that all products or services meet exactly the target value with no variation allowed

Also referred to as robust quality approach

Losses

0.50

Target Value
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Analysis of Quality Costs Quality per the Gurus

Taguchi - there is increasing loss for the producer, the customer, and society associated with increasing variability or deviation from a target value that reflects the ideal state.

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Analysis of Quality Costs Taguchi Loss Function

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Quality Loss Function

For a quality characteristic with the target value T, the loss from having a quality characteristic x can be estimated by this quadratic function:

where:

x = an observed value of the quality characteristic T = the target value of the quality characteristic k = the cost coefficient, determined by the firms failure costs

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Quality Loss Function (cont.)

Your firm has determined that no customer will accept sheet-metal deviating more than .05 from the target value in thickness, that the target thickness is .50, and that the cost to the firm is $5,000 for each rejection by a customer

If the actual thickness of a unit is .47, then the estimated total loss for the unit is:

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Analysis of Quality Costs Quality per the Gurus

Deming - Do not perform quality cost analysis. Spend the money upfront to do the right things the first time. Crosby - Perform a special one time COQ analysis to assess the stage of quality management. Quality is free. Juran - Prepare cost of quality reporting on a periodic basis and use as a management control tool. Economic tradeoff between cost and quality.
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Costs of Quality

Prevention Expenditures incurred to keep quality defects from occurring Appraisal Costs incurred in the measurement and analysis of data to find out if products and services conform to specification Internal failure Costs incurred as a result of poor quality found through appraisal prior to delivery to customers External failure Costs incurred to rectify quality defects after unacceptable products or services reach the customer
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Costs of Quality (cont.)

Prevention costs include:

Appraisal costs include:

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Costs of Quality (cont.)

Internal failure costs include:

External failure costs include:

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Categories of Quality Costs Where is the money spent?

Many companies have high internal and external failure costs And often times appraisal costs are higher than prevention Concentrate on prevention

One rule of thumb is that every $1 spent on prevention can save $10 in appraisal and failure costs

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Conformance and Nonconformance Costs

Cost of Conformity
1. Prevention costs 2. Appraisal costs

Cost of Nonconformity
1. Internal failure costs 2. External failure costs
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Benefits of CoQ Analysis

CoQ can link operational decisions with financial performance CoQ can help with the selection of improvement projects To be useful, quality costs must be accurate

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