How to calculate cost of poor quality

Experience has taught me that the highest quality producer is quite often the lowest cost one. Say what? This is because of a factor called the Cost of Poor Quality, sometimes called Cost of Quality (COQ). Although production of high quality products and services usually requires an investment in equipment, people, or processes, the production of poor quality products undermines the process and creates significant additional cost.

COPQ is a measure of the cost an organization faces due to the provision of substandard products and services. It has 3 components:

• Prevention
• Appraisal
• Failure

It is expressed in numerical form as a percentage of sales, and can be mathematically calculated using the above three factors:

COPQ = Prevention + Appraisal + Failure

Most companies consider only the third factor (failure), which is a measure of rework, warranty returns, and so forth. It is considered a necessary evil to bring customer satisfaction levels back from negative to a neutral, competitor-inspired level. But what if your organization looked at the equation as a complete system? Failure is still considered, but preventing errors from happening, and catching them in production, are equally highly valued. The result is a prevention based system that will result in that ever elusive customer satisfaction increase.

Prevention

The best way to lower the cost of poor quality is to prevent poor quality products or services from being produced in the first place. This is where the biggest gains are possible. It is often the most underrated yet productive part of the COPQ equation. Investment in prevention results in higher customer satisfaction, which is often difficult to measure but at the same time the most important factor to corporate success.

Naturally, there is a trade-off when investment is made in prevention (at the front end) which reduces the number of defective products coming out of the back end. So an investment in prevention is not purely a cost proposition. After increasing product quality, support and technical assistance staff can be reduced once the results are achieved.

As a matter of fact, I would suggest that prevention is the least capital intensive of the three.

Here are a few ideas to include in an effective prevention program:

1. Training
2. Failure Mode and Effects Analysis
3. Pilot projects
4. Design of Experiments
5. Process Capability / Process Performance

Appraisal

This part of the equation represents the cost of measuring quality throughout the production process. You would be surprised how often managers or executives rely on customer feedback (the unsolicited kind) to determine the overall quality of their products. The measurement of product quality at the production level is an essential part of any business unit. If someone asked you what the quality of your units products are, can you give them a good answer, with numbers? If you don’t know this, how are you to expand the business when you don’t have a strong sense of the quality of the products you are promoting?

Inspection, testing, and audits are used to determine quality. Unless the quality is 100%, they result in rework, scraps, and changes to workmanship, handling, specifications, and so forth. All of this is a cost, but an important one. The most important thing is prevention (above), so the better you are at that, the less you will spend on appraisal.

Failure

This factor in the equation represents external issues after the product has left the organization, such as warranty returns, rework, equipment replacement, and so forth. Clearly if the other two factors are done well, this, failure will be minimized, and this is the first priority. I believe you need a strong failure system in place but if the failure rate is high you need to go up the chain and consider prevention and appraisal first.

Failures can result in much more than the costs of returns and rework. Loss of orders, reputation, and future business are some of the more obvious consequences. Lawsuits and malpractice claims due to defective products or services can be a major one time cost. “Due diligence” is often a major consideration in the award of damages, and with a poor reputation the damages will not be on your side. Negotiations with suppliers and clients also take a turn for the worse, with future cost implications.

Typical Values

According to the Quality Digest, some typical values for Cost of Poor Quality in the manufacturing industry are as follows:

Example

Let’s take a producer of furniture. How do you calculate the cost of poor quality? Each of the three items should be itemized and listed. Man-hours and equipment can be calculated for each item.

• Prevention: Sending workers to training and improving processes to reduce defects.  Six sigma projects are great for process improvement.
• Appraisal: Quality control processes, such as inspection before shipment, inspection of paint, and wood working equipment.
• Failure: Cost of warranty replacements, including the office work required to maintain the warranty program.

Have you ever calculated your Cost of Poor Quality? What were the results and what did you learn from the exercise? Leave your comments below, I’d love to hear from you.

The Cost of Quality is the sum of the costs related to providing a quality product and the costs related to not providing a quality product. While an effective measure to identify cash drains, it can also be used to balance the price and quality relationship of your products.

You can also listen to this article:

As a consumer, you probably know that when comparing two similar products, the more expensive one usually comes out as the winner in terms of quality and durability.

This rule also applies to the manufacturing process: to build a product that is better than its rivals, often you will have to be willing to invest more in its production.

At the same time, businesses need to stay competitive in their prices – great quality does not mean anything if a product is not affordable to its price-sensitive target market.

Therefore, it is necessary to find a balance between a product’s quality and its manufacturing costs.

When companies with similar products and comparable marketing strength are competing for customers, the one that tracks their Cost of Quality and uses it in order to fine-tune the quality and price of their product is likely to get ahead.

What is Cost of Quality (CoQ)?

The Cost of Quality (CoQ, also referred to as quality costs) is a method that is used to measure a) the amount of resources used to maintain the quality of products, and b) the amount of costs incurred due to failures, both internal and external.

These two factors are referred to as

a) Cost of Good Quality (CoGQ)

b) Cost of Poor Quality (CoPQ)

The total Cost of Quality can be found by simply adding the CoGQ and the CoPQ:

While the Cost of Quality formula may look extremely basic, it gets a little more complex as you delve into it.

Let us take a look at what the two parts consist of.

Cost of Good Quality (CoGQ)

The cost of good quality accounts for investments made to retain the good quality of your products.

It comprises two smaller categories of costs:

1) Prevention costs signify resources used to prevent failures and poor quality. These include (but are not limited to) costs from:

– Establishment of product specifications and standards

– Product development

– Quality planning

– Quality assurance

– Risk management

– Training

– Supplier qualification

– Etc.

2) Appraisal costs are incurred by reviewing and auditing products and production processes to ensure their conformance to quality standards. These may include:

– Inspections of received goods

– Inspections of finished goods

– Testing

– Equipment monitoring

– Audits

– Process monitoring

– Supplier performance management

– Etc.

Therefore, the Cost of Good Quality is the sum of Prevention Costs and Appraisal Costs:

Cost of Poor Quality (CoPQ)

The cost of poor quality comprises costs incurred due to bad practices, failures, and low product quality.

It is sub-categorized as:

1) Internal failure costs, which are costs related to the low quality of a product detected before it was shipped. These include:

– Unforeseen waste and scrap

– Re-work

– Machinery breakdowns attributable to substandard maintenance

– Failure analysis costs

– Etc.

2) External failure costs, which are costs related to the low quality of a product detected by the customer after it was shipped. These include:

– Returns

– Complaints

– Product recalls

– Service and repairs

– Warranty claims

– Shipping damages

– Etc.

Therefore, the Cost of Poor Quality is the sum of Internal Failure Costs and External Failure Costs:

Of all the types of CoQ, external failure costs are the most expensive: the American Society for Quality estimates that the average thriving company’s cost of poor quality is about 10-15% of all operating expenses.

In worse cases, these costs can make up even 40% of the total expenses of a business.

The general idea of CoQ is that failure costs rise in a much steeper curve than prevention costs and that by investing in preventive measures you can minimize failure costs.

Thus, using the Cost of Quality method could prove to be a valuable addition to your cost-cutting arsenal.

You can use this graph to determine the type of a cost at hand:

Benefits of using Cost of Quality

Implementing the Cost of Quality method will allow you to find a measured balance between the price of your product and its quality.

It provides you with the necessary insight to identify problem areas regarding the quality of your products and the costs related to it.

As a consequence, you can analyze the root causes of product non-conformance and determine where resources could be better allocated to in order to improve your production processes as well as product quality.

This way, you can minimize failure costs and appraisal costs by investing more in prevention.

By minimizing external failures, you will keep your customers much happier, lowering the rate of returns and repairs, and increasing revenues.

In the end, measuring your Cost of Quality can have a major impact on the bottom line of your business.

Using Cost of Quality with an MRP system

Although an MRP system will not calculate the total cost of quality on its own, it can be very helpful both in tracking different quality costs and in implementing preventive measures that would improve your production processes – provided that accurate data is fed into the system.

Among the functionalities that lend a hand in determining the cost of quality are:

• Inspection
  The inspection functionality allows you to track the results of the quality reviews of both your received goods (appraisal costs) and your finished goods (internal failure).
• Return Merchandise Authorization (RMA)
  The RMA functionality helps you manage and keep track of returns, repairs, and replacements (external failures) your customers have demanded.
• Write-offs
  The write-off functionality allows you to track goods that have been written off from stock due to poor quality (internal failures).

Even though these functionalities could prove to be very useful in determining CoQ, the real strength of an MRP system lies in its capabilities to organize and standardize data and processes, and to support the implementation of proper procedures that would prevent failures.

That makes using an MRP system a cost of good quality.

Read more about How Manufacturing ERP Improves Quality in the Workplace.

Conclusion

Considering that a large portion of a company’s spend is related to the Cost of Quality, it is wise to measure it to make informed business decisions.

CoQ can help determine problem areas and, consequently, reduce returns and complaints, and increase sales and profits thanks to the improved quality of your products.

If done right, using it in conjunction with an MRP software could contribute a lot to the amelioration and standardization of your manufacturing processes and, by way of that, to the long-term growth of your company.

You may also like: Maintenance Management – Becoming Proactive With Modern Manufacturing Software