Quality and the Bottom-Line

 So much has been said about the need to implement a quality management system, and in most cases in accordance with the requirements of ISO 9001:2015, the current version of the standard. What not much is explicitly being said about is how quality actually affects the bottom line of the company, there where it really matters, in terms of Rands and Cents. Apart from often being quite an expensive effort to implement and maintain such a system, how does quality per se affect the economics of the company?

Quality affects the economics of the company in two ways:

The effect on cost: If we define quality as freedom from defects, what could be termed as a "higher" degree of quality (in other words, less defects), should lower the operational costs.

The effect on income: We define income as all income into the company for the purpose of this discussion. It includes sales and all other forms of income, and refers to gross income, not profit. Because quality products and services are essentially those that will satisfy the needs and expectations of customers, it can be reasonably expected that those satisfied customers will keep coming back, and will give referrals, thus increasing income.

It is important to realize that these two categories are interactive. Product or service deficiencies will increase operational cost and decrease income (as a result of complaints, warranty claims, etc, which are not good for business).

There is always a high correlation between deficiencies discovered inside the organization, and customer complaints. The more deficiencies discovered internally (sample based), the higher the probability that some deficiencies will not be discovered, and will reach the customer (unless the company has a waterproof inspection and testing system, which in itself will increase operational cost).

Success in reducing deficiencies through quality improvement (a primary objective of the quality management system) is a form of cost reduction. It makes the company more effective, and enables it to achieve a larger market share. The quality management system endeavours to achieve this through prevention activities, not reactive inspection and testing. This is the reason why the standard requires the application of risk based thinking or RBT.

Customers vs. suppliers

 Everybody sells their products and services to customers. It is essential to realize that our customers are not necessarily always the end-users. Our customers may acquire products from us for further processing, or they may be wholesalers or retailers, etc. This in turn makes them suppliers to their customers.

Let us look at the concept of quality again. Customers and suppliers will clearly have different viewpoints of what makes a product or service acceptable in terms of quality. If these differences are not resolved between the customer and the supplier, it is always the supplier who will be in trouble. The customer can simply go somewhere else to purchase the goods or services.

To illustrate the different viewpoints, consider the following:

·         What is bought: The customer sees it as a product or service that he or she needs. The supplier sees it as goods manufactured or as services delivered.

·         Definition of quality: The customer sees it as fitness for use during the life of the product or service. The supplier sees it as conformance to specifications on the final test.

·         Cost: The customer sees cost as the cost of use, including the purchasing cost, operating costs, maintenance, downtime, depreciation and loss on resale. The supplier sees it as the cost of manufacturing or service delivery.

·         Responsibility for the product to be kept in service: The customer wants the product to be useful over its entire useful life. The supplier sees it as during the warranty period.

·         Spare parts: The customer sees the need for spare parts as a necessary evil. The supplier, on the other hand, sees the manufacturing and sales of spare parts as a profitable business.

Customer knowledge

Customers are spoiled for choice in this day and age. They have multiple sources of supply available to them (in most cases). When they are looking for products or services to buy, they will, amongst other things, consider quality.

Research has shown that original equipment manufacturers (OEMs) can protect themselves through their technological and / or economic power as much as through contract provisions. Merchant and repair shops must mainly rely on contract provisions, supplemented by some economic power. Small users or consumers have very limited knowledge and protection.

Small users will most often not understand the technological nature of the product. But they do have some sensory recognition of some aspects of quality or fitness for use, like smell, look, feel, etc. This is why some suppliers can keep on selling products that are not very good quality to consumers, often based on brilliant marketing strategies.

For long life products, the user will often rely on past experiences with the supplier (not necessarily his own experiences). If no such experience is available, the user will rely on information made available by different suppliers, like advertising, brochures, etc.

The manufacturer is thus affected by the user's lack of knowledge. It can have either positive or negative effects, regardless of the actual quality of the products of the supplier.

Compare the effect of customer perception on the resulting income to the manufacturer:

·         The customer sees the product as not fit for use. The manufacturer's income potential is immediately in jeopardy, because he will not be able to sell, or, if he did sell, there will be comebacks and complaints

·         The customer sees the product as fit for use, but noticeably inferior to competitive products. The manufacturer will have to reduce prices and thus potentially have a much lower income than desired.

·         The customer sees the product as fit for use and competitive in terms of other similar products on the market. The manufacturer can now sell at market related prices, ensuring a good income for the company.

·         The customer sees the product as noticeable superior when compared to competitive products. The manufacturer can now sell at premium prices, or a much larger market share will be obtained, increasing the income potential significantly.

How does quality influence prices?

Product price is influenced by product quality. The relationship between price and quality is not always very clear, because there are other influences as well, and good quality does not always equal higher prices, and higher price does not always equal good quality, simply because the customers are not always buying the better quality product, for a variety of reasons.

We need to differentiate between consumer products and industrial products if we are going to understand the relationship between quality and price.

Consumer products

It has been concluded over many years that there is very little correlation between the price of consumer products and product quality. There is a perception amongst consumers that more expensive products are of better quality. This perception is, however, changing, possibly due to marketing strategies, or because users are becoming more educated and aware of quality.

Branded products are often sold at much higher prices than generic products, to the point where the difference in price is extreme. Branded products are also often of lower quality than generic products, because the manufacturers of generic products have to rely on quality, since they do not have "the name" in the market. The reason why users are often willing to pay extreme prices for branded products is because of perceived quality differences. This is once again based on the fact that users often believe that more expensive has to be better quality.

Consumers are known to often have a unique interpretation of the terms quality and price. This interpretation influences their perceptions. Quality is often interpreted as factors which go beyond the inherent functional characteristics of the product. Price, on the other hand, is often interpreted as relating to "value" and is paid for these added factors, along with the inherent functional features. This is why most South African car manufacturers, rather than lower the price of the cars by providing “budget” vehicles (still quality vehicles, but without all the bells and whistles), add additional features, such as service plans, as well as added features to the vehicles. Bottom line is that the customer still pays for the added value. But, as we have seen over recent years, there has been a market developing for basic, budget vehicles, due to economic pressures on consumers. But we have also seen that customers, if they can afford it at all, will in many cases rather go for the “added value”, and pay more, but, again, if they can afford it. Also, the so-called “basic” vehicles available do not afford customers much choice. What we have seen, is that, when a cheap Chinese model did come on the market, with some of the “added” value features, but the real quality in terms of reliability, etc was really not good, customers very quickly turned their backs on the brand. It has also happened before with vehicles from Eastern Europe which were very basic, but technology was old, build-quality was bad and reliability was bad. If acceptable levels of quality are absent, cheap price will not save the brand.

So vehicle manufacturers in South Africa have realize that, given the choice, customers will more often than not go for the vehicle that they perceive to be the quality vehicle in terms of value, not necessarily only because of the inherent quality of the vehicle, but the “added value” because of the extra features.

Industrial products

Industrial buyers are generally much better informed as to the significance of the concepts of quality, price and value. They are also more knowledgeable about technology and economic information.

In today's competitive market it is impossible to apply the principle of "standard product - standard price". Think about the automotive industry, where a "basic" model includes all sorts of extra features. It is almost impossible to buy a "standard, basic" car. Almost all of them come with features like air conditioning, air bags, ABS brakes, sound systems, etc.

If the difference in quality between products is obvious, buyers and sellers are willing to establish a price difference. The big issue is: "How much?"

If we compare commodities against specialized products or systems, we will typically find the following:

·         Commodities are typically bough at market prices

·         Price dominates the purchase decision for commodities

·         Special products are not standard

·         Special products include additional attributes which will result in premium prices

When products are sold as specialist products, prices are often bundled, providing no breakdown of price between goods or commodities and the associated services, unless the buyer insists on such a breakdown.

Pricing strategy has an effect on market share and the overall profitability of the organization.

Higher quality products afford the manufacturer to reap higher benefits, through either higher price or larger market share. It has been found that companies in general opt for higher price.

Influence of Quality on Market Share

Market share is the proportion of the total market that a company obtains when a product or service is put on the market. The larger the market share, the more successful the company is perceived to be. It can reasonably be expected that the higher the market share, the higher the generated profits will be.

Profits increase disproportionably, due to the nature of the breakeven chart.

Example of a Breakeven Chart

 

The Effect of Superior Quality on Market Share

There are 5 possible scenarios when it comes to quality (from the buyers point of view), compared to the products of your competitors. The effects are very important, because it will determine marketing strategy and price.

·         Obvious superior quality: The obvious superior quality translates into higher market share.

·         Quality superiority translatable into user economics: This happens when products may look alike, but some products have superior qualities that are not obvious, like a car that has better fuel consumption than a similar, other car. It becomes important to make the buyer aware of the superior technological qualities. The superior qualities must be demonstrated in terms of the users’ system of values to stimulate them to take action. If superiority is successfully demonstrated, higher market share will be obtained.

·         Marginal superior quality which can be demonstrated: The product without the slight superiority may be found to be adequate for the users’ needs. If the manufacturer can demonstrate that the product is superior effectively, higher market share may be obtained. It becomes vital that the buyer is adequately sensitized.

·         Superior quality accepted on faith: Sometimes the buyer will not be able to verify the superiority of the product. The manufacturer will then try to “prove” that the product is indeed superior. He will use independent tests, etc. If successful, the buyer will except on faith that the product is better, and will buy, resulting in higher market share.

·         Quality is not superior: If it cannot be demonstrated that the product is in any way better than other similar products, it will all be up to the skills of the marketers. They will insist on attractive packaging, or larger packaging, etc. It has been found that price reduction is often not a solution, because the resulting increase in market share is only temporary.

Market share is influenced by consumer preference. This indicates that the organization needs to measure consumer preference to ensure that it will make the correct marketing decisions. This could, in some cases, be easy, while for other products it may be very difficult.

Marketing skills, which relies on attractive packaging, the reputation of the manufacturer, etc, as well as the contents of the package, may influence buyers. The product is judged by the buyer’s preferences and sense of quality, which will make him or her prefer some products and not other products.

For simple consumer products the preferences of the buyer may be fairly easy to identify. For more complex products this may become very difficult. To acquire data for analysis from consumers may vary from fairly easy to very difficult.

Unlike consumer products, which are normally sold on the sensory quality, industrial products are normally sold on technological performance. Preferences will, however, still play an important role.

There is a need to find ways of relating qualities to customer preference and to market share. Sales analysis needs to be carried out to determine buyer preference. Other methods can also be used, like company performance when bidding for contracts.

I trust that this information is useful. For more information or feedback please contact me at koosgouws10@gmail.com.  You can also visit our website at www.sheqmanagementsystem.co.za, or alternatively www.sheq-management-systems.webnode.com.

Koos