MacroEconomics of Quality

Issues + Why Estimate Cost of Quality Failures? + Quality Costs are Far Greater than Those that are Readily Identifiable (Iceberg Principle) + Gains to be Made if Cut Measured Quality Losses in Half + How to Reduce Quality Losses uRule of “Tens” uEradicate Killer Re’s uPlay Offense (Prevention) vs. Defense (Detection) + Sound Quality Practices

Why Estimate Cost of Quality Failures + Quantify the Cost of Quality Failures for the Business uIdentify magnitude of potential savings uSensitize Management to the size of the opportunity uHelp to re-expose problems we have learned to tolerate + Identify the Highest Loss Areas + Permit Prioritizing the Loss Areas for Corrective Action

Economics of Quality: TCE Statistics TV Units Sold5 million + Estimated Revenues$2.5 billion (5 x $500 per set) + Estimated Earnings$125 million (5% of Sales)

+Scrap (Measured)$12 million +Total Cost of Quality$ million (Measured & Hidden) +Cost of Scrap per TV(12/5)$2.40 per unit +Total Cost of Quality$ $120 (M+H) per TV Sold (6/1 to 50/1 Iceberg) +% Total Cost of Quality3% - 24% per TV/Selling Price (14.40/ /500) +# Defects per TV? Economics of Quality: TCE Statistics 1994

Economics of Quality: STB Systems Statistics Units Sold6 million 4 Estimated Revenues$300 million (6 x $50 per unit) 4 Estimated Net Earnings$16.2 million (5.4% of Sales)

Average 4 Scrap (Measured)$ million $ Total Cost of Quality$ million $52.5 (Measured & Hidden) Cost of Scrap per Unit$.3125 per unit $.3125 (1.875/6) 4 Total Cost of Quality $ $ $8.75 (M+H) per Unit Sold (6/1 to 50/1 Iceberg) 4 % Total Cost of Quality3.75% % 17.5% per Unit/Selling Price (1.875/ /50) 4 # Defects per Unit???

Cost of Quality Failures

ICEBERG PHENOMENON Direct/Measured Costs: Scrap/Rework Service Calls Service Calls Warranties/Concessions Warranties/Concessions Indirect/Hidden Costs: Excess Inventory Excess Inventory Overtime Overtime Reputation/Image Reputation/Image Hidden Costs = 6 to 50 times Measured Costs

Cost of Quality Failures Worksheet FAILURE COST CATEGORIESESTIMATED ANNUAL COSTS $(000) MEASURED COST OF QUALITY +Internal uWaste, Scrap____________________ uRework____________________ uReinspect____________________ +External uWarranties____________________ uGuarantees____________________ uConcessions____________________ TOTAL MEASURED__________________

HIDDEN COST OF QUALITY + Internal uTroubleshooting and failure analysis__________________ uEvaluation to determine usability of off specification material__________________ uEngineering changes, redesign, buy-offs__________________ uCosts of reviewing quality problems (i.e.,replanning, meetings, expediting, firefighting, reports, etc.)__________________ uInventory costs on held material__________________ uOvertime because of quality problems __________________ uLate shipment premiums (delayed collections)__________________ uMaterial handling__________________ uTool & fixture redesign__________________ uMachine wear__________________ uFringe benefits on labor__________________ uLoss of productivity due to rework, scrap__________________

HIDDEN COST OF QUALITY + External uLoss of market share due to poor quality reputation____ uLoss of profitability____ uLoss of bond credit rating____ uOther  ___________________________________________________  ______________________________________________ Total Hidden ____ Grand Total ____

WHAT IF ??? We could cut losses in half? 1/2 x $12,000,000 …………………......$6,000,000 If ICEBERG is between 6/1 to50/1……$36,000,000 to $300,000,000 Total TCE net earnings in 1994 were?

WHAT IF??? 4 We could cut losses in half? 4 1/2 x $1,875,000$937,500 4 IF ICEBERG is between 6/1 to 50/1 $5,625,000 to $46,876,000 4 Total STB Systems net earnings for 1998 estimated to be $26,250,000 $16.2 million

Economics of Quality: STB Systems Statistics (1997 vs. 1998) Sales$190 million$300 million Net Earnings (Income) $10.26 million$16.20 million (5.4% of Sales) COQ as of % of Sales % COQ ($)$ million$ million What if COQ cut in half?$ million$ million (Savings)($16.63 million)($26.25 million) Net Income with Savings $26.89 million$42.45 million

How to Reduce Quality Losses + Rule of “Tens” + Eradicate Killer Re’s…Waste + Play Offense (Prevention) vs. Defense (Detection)

RULE OF “TENS” Not doing it right the first time costs ten times as much to find and fix each time errors escape to a subsequent stage of handling. $1 Design Effort =$10 Production Cost =$100 Assy/Test Cost =$1000 Field Cost

The Killer Re’s

Computing Cost of Quality Internal Failure 4 Scrap 4 Rework 4 Scrap/Rework - Supplier Appraisal 4 Inspection 4 Test 4 Quality audits 4 Test equipment - initial cost & maintenance External Failure 4 Cost to customer 4 Warranty costs 4 Complaint adjustments 4 Returned material Prevention 4 Quality planning 4 Process planning 4 Process control 4 Training Note: The listed categories provides an understanding of the COQ structure. In general, COQ is comprised of costs due to failure, appraisal, and prevention.

The Enlightened Perspective Quality Internal & External Failure Appraisal & Prevention 44 55 66 Old Belief New Belief

Sound Quality Practices + Operational Definitions and Standards (Metrics) + Manage by Fact u“In God we trust. But everyone else must bring data!” uWithout good data, everyone is an expert + Focus on Process (Offense) vs Product Results (Defense) + Reduce Variation

Questions?