The last blog that I posted quoted some information from a book by Philip B Crosby, titled “Quality is Free”. In the opening section of the book, Crosby makes the following statement: “Quality is free. It is not a gift, but it is free. What costs money are the unquality things – all the actions that involve not doing jobs right the first time”. Crosby goes on to say that not only is quality free, it is "an honest-to-everything profit maker”.
But there is a problem for many organizations. How do we measure the costs of quality? Typically organizations look at things like the number of customer complaints, defect ratios, products returned, field failures, warranty claims, etc. So, how does this relate to accurate financial reporting?
In many organizations it does not. Financial statements are very precise when it comes to things like inventory, sales figures, marketing costs, employee compensation, etc. But quality? It is reported as “good”, “not quite on par”, “deteriorating”, etc. Hardly anything to do with quantifying quality costs.
Some companies are naturally measuring some quality costs, like warranty costs, replacement costs, sometimes inspection costs, auditing costs (as long as they are external audits), etc. But that does not provide us with a complete picture.
Part of the problem is that some of the quality costs are “hidden”. Without proper understanding of what quality costing is it becomes almost impossible to measure.
There is also a second problem. The quality department is made responsible for the measuring of quality costs. Now, let us be honest, these guys know something about quality, but mostly nothing about finance and costing. This activity actually belongs where all financial measurements should be – the finance department. They know how to quantify things in terms of money, and where to find the numbers.
In a management meeting we are likely to hear things like: “Our receiving inspection rejection rate has increased from 2,5% to 4% in the last month. This is due to ….”, etc. More what we would like to hear, but we need to see the bigger picture, and, how accurate are those figures anyway? Do they include all the actual costs, or are they based purely on reject rates?
So, if Crosby is right, quality may be free, but nobody is ever going to know it if we do not have some system of accurate monetary measurement. But what do we need to measure, and how does it actually work?
Quality Costing Broken Down in its Various Categories
There are two main categories of quality costs. These are, according to Crosby, the Price of Conformance (PoC) and the Price of Nonconformance (PoNC). I think that these are good descriptions for the categories, and I also think that it is immediately apparent that it is better to spend money to ensure conformance, rather than to spend money on nonconformances. And that is right. We just need to know how much expenditure would be acceptable.
So, let us start by looking at the price of conformance. It includes every cent spent to make quality certain. We find two different categories – Prevention Costs and Appraisal Costs.
Prevention Costs
Prevention costs include the cost of all activities that aims to prevent defects in the design, development, purchasing, manufacturing, marketing, delivery, etc in our products and services.
Specific examples of these activities include:
- Quality planning
- Quality auditing
- Assuring vendor or subcontractor quality
- Reviewing and verifying (including design, product and process reviews)
- Process control engineering
- Design and development of quality measurement
- Quality training
- Acquisition analysis and reporting quality data
- Quality improvement programs
- Product recall and liability insurance
- Planning for product recalls
- Etc
Appraisal Costs
Appraisal costs are incurred through inspections, tests, and other planned evaluations to determine if products or services conform to the specified requirements. Requirements include specifications from marketing and customers, as well as specifications for processes and procedures. All documents describing the conformance of a product or service are relevant.
Specific examples include:
- Design appraisal
- Receiving inspection
- Inspection and testing
- Inspection and test equipment
- Material consumed during inspection and testing
- Analysis and reporting of test and inspection results
- Field performance testing
- Approvals and endorsements
- Stock evaluations
- Etc
These two categories are seen as the “good” costs, in terms of quality. But then we have what is regarded as the “bad” costs. This is what Philip Crosby called the Price of Nonconformance. There are also two categories, and both are regarded as failure costs. These are Internal Failure Costs and External Failure Costs.
Internal Failure Costs
Internal failure costs are associated with defective products, components and materials (include services as products as well) that fail to meet the quality requirements and that leads to production or service delivery losses, amongst other costs.
These costs include:
- Scrap
- Replace, rework or repair
- Re-inspection and retesting
- Defect diagnosis
- Disposition determination
- Downtime
- Down-grading
- Etc
External Failure Costs
External failure costs are generated when defective products or services are delivered to the customer. This is particularly bad, because the customer knows about it, and it affects the reputation of the organization.
Some of the examples included here are:
- Customer complaints
- Warranty claims
- Product rejected and returned
- Concessions
- Loss of sales
- Recall costs
- Product liability costs
- Etc
The failure costs of the organization impacts on several areas in the organization. There are administrative costs, operational costs, sales and marketing costs and engineering costs. The list could go on.
Often the real impact of failure costs can be difficult to quantify. Looking at the impact on sales and marketing, how does one quantify loss of market share as a result of bad quality or even more difficult, the loss of customer goodwill?
More information can be found in another of Philip Crosby’s books, “Quality without Tears”. But that is a topic for another day!
So, the question remains- Is quality free? Yes, if we spend money on the right things! It then pays for itself in terms of less income being spent on unnecessary things, in particular on defective output. Defective output means that we must redo, rework, etc, and that in time that more productive output could have been achieved. As such, a double waste of money. Instead of doing it right the first time, and then doing it right again, resulting in more sellable outputs, we do it wrong, and then fix. Less sellable output! We need to spend only the right amount of money in terms of sales Rands, Dollars, Pounds, Euros, etc. Money spend to make quality certain, not to fix what we have done wrong. Money spend on prevention and appraisal costs, not failure costs.
So, how much money should we be spending on quality in terms of sales income? It is generally accepted that we should not spend more than 2.5% of sales income on quality, although this figure may fluctuate in terms of different industry sectors. The expenditure should also be measured accurately so that we know exactly what we are spending on quality.
Finally, quality in the organization can be reported in terms that most managers and leaders understand – MONEY.
The implementation of a quality management system will benefit the organization. Graphically the effect can be shown as follows:
So, where to start? I think a good place to start is to have a conversation with the quality guys and with the finance guys to work out a strategy. And get as much information on the topic as you can!
Feel free to contact me at koosgouws10@gmail.com for more information or any enquiries. Also visit our website at www.sheqmanagementsystem.co.za
You can also leave a comment in the comments section.
Regards
Koos
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