IE673Session 11 - Cost of Quality1 Cost of Quality

IE673Session 11 - Cost of Quality2 What are Quality Costs? A quality product or service is one that conforms to customer expectations. –Assume that Design specifications are for product Product meeting specifications meet customer expectations Can determine adherence to specifications

IE673Session 11 - Cost of Quality3 Quality costs are costs incurred because poor quality may or does exist Broad categories of quality costs –Prevention costs –appraisal costs –Internal failure costs –External failure costs

IE673Session 11 - Cost of Quality4 Uses of Quality Cost Information Alerting executives to potential impact Motivating action to improve quality Help determine types of activities to reduce quality costs Prioritize quality improvement efforts

IE673Session 11 - Cost of Quality5 Concepts of Quality Common misconceptions –Productivity and quality are incompatible –Higher quality can only be obtained at higher cost Webster’s Dictionary defines quality as: –that which makes something what it is; characteristic; attribute –basic nature;characteristic; kind –the degree of excellence which a thing possesses –excellence; superiority

IE673Session 11 - Cost of Quality6 Grade, Expectations, Specifications, and Actual Results Quality - “Conformance to customer expectation” or “fitness for use” Three primary determinants –Customer expectations –Product Specifications –Actual results

IE673Session 11 - Cost of Quality7 Grade relates to the difference in customer expectation between products having the same functional use. Customers compare products having the same functional use and develop expectations for the relative performance of alternative products.

IE673Session 11 - Cost of Quality8 Designing a New Product Customer Expectation Functional Specification Manufacturing Specification Actual Results Design Specification Step 1 Step 2 Step 3 Step 4 High Grade Low Grade

IE673Session 11 - Cost of Quality9 Step 1 in the Design of a New Product Restate customers qualitative expectations into quantitative functional specifications –Functional Specifications are quantitative statements regarding the capabilities of the product

IE673Session 11 - Cost of Quality10 Step 2 in the Design of a New Product Develop design specifications that meet the functional requirements –Design specifications will include statements regarding the physical characteristics of the product (engineering drawings)

IE673Session 11 - Cost of Quality11 Step 3 in the Design of a New Product Develop manufacturing specifications –Manufacturing specifications specify in detail how the product is to be produced and what its physical characteristics should be at each step of the production process

IE673Session 11 - Cost of Quality12 Step 4 in the Design of a New Product Manufacture the product using the manufacturing specifications –If all steps have been carried out perfectly, the actual results is a product that meets customer expectations

IE673Session 11 - Cost of Quality13 Quality of Design/Conformance Ultimate test - compare customer satisfaction with actual product –Seldom possible; expectations are qualitative –Design specification often used as standard Two possible sources of error –Differences between customer expectations and design specification –Differences between design specifications and the actual product

IE673Session 11 - Cost of Quality14 Quality of Design Refers to the degree of conformance between customer expectations and design specifications for product Ensuring conformance is critical to proper evaluation of product quality

IE673Session 11 - Cost of Quality15 Quality of Conformance Degree to which a product or service conforms to its design specification –If specification allows no dents –If specification allows one 1/2” scratch –What about customer?

IE673Session 11 - Cost of Quality16 Determination of Grade Decisions regarding grade are based on –Organizational choice –Market identification Higher grade is attained at greater cost to producer and consumer High grade does not ensure high quality or high conformance

IE673Session 11 - Cost of Quality17 If “quality” refers to grade –positive correlation with cost If “quality” refers to conformance –negative correlation with cost

IE673Session 11 - Cost of Quality18 Productivity A measure of the efficiency of resource use –Not the same as production - volume of output –Ratio of outputs to inputs Increased productivity is the source of increases in real wealth Changes in national productivity –Government policy –Management decisions

IE673Session 11 - Cost of Quality19 Improving Quality Through Quality The relationship between quality of conformance, productivity, and production costs –Higher quality of conformance - lower rejection rates –Lower rejection rates - less waste of materials, labor, and/or equipment time

IE673Session 11 - Cost of Quality20 Quality, Productivity, and Profitability Increased Quality Lower Unit Costs Lower Unit Costs Lower Unit Costs Higher Selling Price For Quality Premium Selling Price Unchanged Higher Margin Lower Selling Price Higher Unit Margin Consistent Sales Volume Higher Sales Volume Increased Sales Volume Increased Profit

IE673Session 11 - Cost of Quality21 Profitability Quality costs - basis for evaluating investments in quality programs –Cost Improvement –Profit Enhancement –Other Benefits

IE673Session 11 - Cost of Quality22 Why Measure Quality Costs? Dollars can be added across departments/products Total dollars more meaningful to top management Helps identify quality problems and opportunities Helps evaluate relative importance of quality programs Demonstrate the worth of improvement programs Aid in budgeting quality costs Evaluate company’s success in achieving quality goals

IE673Session 11 - Cost of Quality23 Quality Cost Reports Periodic summaries by: –Organization unit –Product –Other segments of interest –Organization as a whole Prepared –Monthly –Annually –Other period of time

IE673Session 11 - Cost of Quality24 Reports may contain –Data for current period –Data for corresponding period last year –Budgeted quality costs for current period –Year-to-date information

IE673Session 11 - Cost of Quality25 Quality Cost Trend Analysis Pie chart shows relative cost distribution for a single period Bar/line charts better for showing changes with time Trends of more interest to management

IE673Session 11 - Cost of Quality26 Quality Cost Trend by Quarters

IE673Session 11 - Cost of Quality27 Relating Quality Costs to the Level of Activity Changes in level of activity can make interpretation difficult Restate quality costs as a % of some standard measure –Standard manufacturing costs –Standard direct material –Standard direct labor costs –Standard direct labor hours

IE673Session 11 - Cost of Quality28 Relating Quality Costs to Financial Performance Methods vary widely –Income statement approach; bottom line % of Sales % of profit –Example (Hartford Insurance Group) Expressed in terms of labor-hours devoted to each element Then restated in terms of number of persons needed Ultimately - number of persons needed because of poor quality

IE673Session 11 - Cost of Quality29 Uses of Quality Cost Information Indicating the financial significance of quality costs Helping identify relative importance of quality problems Indicating if there is a maldistribution of quality costs Establishing goals or budgets for quality costs Evaluating the performance of quality improvement projects Evaluating capital expenditure proposals

IE673Session 11 - Cost of Quality30 Limitations of Quality Cost Information Quality cost measurements do not solve quality problems Quality cost reports do not suggest specific actions Quality costs are susceptible to short-term mismanagement It is difficult to match effort and accomplishment Important costs may be eliminated from reports Inappropriate costs may be included in reports Many quality costs are susceptible to measurement error

IE673Session 11 - Cost of Quality31 Twelve Steps to System Installation Obtain management commitment and support Establish an installation team Select a single organization segment as a prototype Obtain cooperation and support of the users/suppliers of information Operationally define quality costs and quality categories Identify quality costs within each category Determine sources of quality information Design quality cost reports and graphs Establish procedures to accumulate information Accumulate information, prepare and distribute reports Eliminate bugs Expand system