1. 15-1 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Quality Costs and Productivity: Measurement, Reporting, and Control 15 PowerPresentation® prepared by David J. McConomy, Queen’s University

2. 15-2 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Learning Objectives l Identify and describe the four types of quality costs. l Prepare a quality cost report and explain the difference between the conventional acceptable quality level (AQL) view and the zero defects view of quality cost control.

3. 15-3 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Learning Objectives l Explain why quality cost information is needed and how it is used. l Explain what productivity is and calculate the impact of productivity changes on profits.

4. 15-4 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Eight Dimensions of Quality l Performance l Aesthetics l Serviceability l Features (quality of design) l Reliability l Durability l Quality of Conformance l Fitness of Use

5. 15-5 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Quality Defined l Features (Quality of Design) refer to characteristics of a product that differentiate functionally similar products. –Example: Compare first class air travel with economy travel. First Class typically offers more leg room, better meals and more luxurious seats. l Quality of Conformance is a measure of how well the product meets its requirements or specifications. –Example: If a Honda Civic does what it is designed to do and does it well, quality exists. For example, if economy cars are designed to provide reliable, low- cost, low-maintenance transportation, the desired quality exists.

6. 15-6 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Measuring Quality Costs l Prevention costs l Appraisal costs l Internal failure costs l External failure costs

7. 15-7 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Examples of Quality Costs Prevention costs Appraisal Costs Quality engineeringInspection of raw materials Quality training programsTesting of raw materials Quality planningPackaging inspection Quality reportingSupervising appraisal activities Supplier evaluation and selectionProduct acceptance Quality audits Process acceptance Quality circlesInspection of equipment Field trialsTest equipment Design reviewsOutside endorsements

8. 15-8 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Examples of Quality Costs Internal failure costs External failure costs Scrap Cost of recalls Rework Lost sales Downtime (defect related) Returns/allowances Reinspection Warranties Retesting Repairs Design changes Product liability Customer dissatisfaction Lost market share Complaint adjustment

9. 15-9 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Estimating Hidden Quality Costs l The Multiplier Method l The Market Research Method l Taguchi Quality Loss Function Hidden Quality Costs are opportunity costs resulting from poor quality.

10. 15-10 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. The Multiplier Method The multiplier method assumes that the total failure cost is simply some multiple of measured failure costs: – Total external failure cost = k(Measured external failure costs) – where k is the multiplier effect – If k =4, and the measured external failure costs are $2 million, then the actual external failure costs are estimated to be $8 million.

11. 15-11 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. The Market Research Method The market research method uses formal market research methods to assess the effect of poor quality on sales and market share. –Customer surveys and interviews with members of a company’s sales force can provide significant insights into the magnitude of a company’s hidden costs. –Market research results can be used to project future profit losses attributable to poor quality

12. 15-12 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. The Taguchi Quality Loss Function The Taguchi loss function assumes any variation from the target value of a quality characteristic causes hidden quality costs. –Furthermore, the hidden quality costs increase quadratically as the actual value deviates from the target value.

13. 15-13 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Reporting Quality Costs Quality Costs % of Sales Prevention costs: Quality training $35,000 Reliability engineering 80,000$115,000 4.11% Appraisal costs: Materials inspection$20,000 Product acceptance10,000 Process acceptance 38,00068,0002.43% Internal failure costs: Scrap$50,000 Rework 35,00085,0003.04 % External failure costs: Customer complaints$25,000 Warranty25,000 Repair 15,000 65,000 2.32% Total quality costs$333,00011.90% ============

14. 15-14 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Reporting Quality Costs (continued)

15. 15-15 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. AQL Quality Cost Graph Cost 0 Optional (AQL) Percent Defects 100% Cost of Failures Cost of Control

16. 15-16 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Zero-Defect Graph Total Quality Cost 0 Percent Defects100%

17. 15-17 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Multiple-Period Quality Costs Quality Costs Actual Sales % of Sales 2001 $440,000 $2,200,000 20.0 2002 423,000 2,350,000 18.0 2003 412,500 2,750,000 15.0 2004 392,000 2,800,000 14.0 2005 280,000 2,800,000 10.0 Assume the following data:

18. 15-18 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Multiple-Period Trend Graph: Total Quality Costs 5 10 15 20 0 1 2 3 4 5 % of Sales Year

19. 15-19 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Multiple-Period Total Quality Costs Total Quality Costs as a % of Sales 0 5 10 15 20 25 20012002200320042005 Column 2 %of Sales

20. 15-20 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Multiple-Trend Analysis for Individual Quality Costs Internal External Prevention Appraisal Failure Failure 2001 6.0% 1 4.5%4.5%6.0% 2002 6.04.03.54.5 2003 5.43.63.03.0 2004 5.6 3.23.12.6 2005 4.4 2.4 3.02.3 Assume the following quality cost data: 1 Expressed as a % of sales

21. 15-21 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Multiple-Trend Analysis for Individual Quality Costs % of sales 0 5 10 15 20 25 20012002200320042005 External Costs Internal Costs Appraisal Prevention

22. 15-22 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Productivity: Measurement and Control Productivity is the relationship between output and the inputs used to produce the output. Total productive efficiency is the point at which two conditions are satisfied: 1.for any mix of inputs to produce a given output, no more inputs are used than are necessary to produce that output 2.given the mixes that satisfy the first condition, the least costly mix is chosen.

23. 15-23 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Illustration of Productivity Improvement Technical Efficiency is the condition where no more of any one input is used than necessary to produce a given output. –Technical efficiency improvement is when less inputs are used to produce the same output or more output are produced using the same input.

24. 15-24 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Illustration of Productivity Improvement Same output, fewer inputs: INPUTS OUTPUT

25. 15-25 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Illustration of Productivity Improvement More outputs, same inputs: INPUTS OUTPUT

26. 15-26 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Input trade-off efficiency is when a less costly input mix is used to produce the same output. Combination I: Total cost of inputs = $20,000,000 INPUTS OUTPUT Illustration of Productivity Improvement

27. 15-27 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Illustration of Productivity Improvement Combination II: Total cost of inputs = $27,000,000 INPUTS OUTPUT Of the two combinations that produce the same output, the least costly combination would be chosen.

28. 15-28 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Partial Productivity Measures l Partial Productivity Measurement: Measuring productivity for one input at a time. Partial Measure = Output/Input l Operational Productivity Measure: Partial measure where both input and output are expressed in physical terms. l Financial Productivity Measure: Partial measure where both input and output are expressed in dollars.

29. 15-29 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Partial Productivity Measures Example 1: In 2000, Tick-Tock Company produced 100 clocks and used 200 direct labour hours and 50 kilograms of raw materials. Compute the labour and materials productivity ratios. Answer: Labour productivity ratio = 100 clocks/200 hours = 0.5 clocks per hr Materials productivity ratio = 100 clocks/50 kilogram = 2 clocks per kilogram

30. 15-30 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Partial Productivity Measures Example 2: In 2001, Tick-Tock Company produced 100 clocks and used 175 direct labour hours and 40 kilograms of raw materials. Compute the partial productivity ratios. Compared to 2000, has productivity improved? Answer: A.Ratios computed: –Labour productivity ratio= 100 clocks/175 hrs = 0.57 clocks per hr –Materials productivity ratio= 100 clocks/40 kilograms = 2.5 clocks per kilogram B. Ratios compared: 20002001 Labour0.500.57 Materials2.002.50 Both ratios have improved, so productivity has improved.

31. 15-31 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profile Measurement Profile Measurement provides a series or a vector of separate and distinct partial operational measures. Example: Kankul implements a new production and assembly process in 2001. Only now let’s assume that the new process affects both labour and materials. The following data for 2000 and 2001 are available 20042005 Number of motors produced120,000150,000 Labour hours used40,00037,500 Materials used (kg)1,200,0001,428,571

32. 15-32 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profile Analysis with No Trade-offs Partial Productivity Ratios 2004 Profile a 2005 Profile b Labour productivity ratio3.000 4.000 Materials productivity ratio0.100 0.105 a Labour: 120,000 / 40,000; Materials: 120,000 / 1,200,000 b Labour: 150,000 / 37,500; Materials: 150,000 / 1,428,571

33. 15-33 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profile Analysis with Trade-offs Partial Productivity Ratios 2004 Profile a 2005 Profile b Labour productivity ratio3.000 4.000 Materials productivity ratio0.100 0.088 a Labour: 120,000 / 40,000; Materials: 120,000 / 1,200,000 b Labour: 150,000 / 37,500; Materials: 150,000 / 1,700,000

34. 15-34 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profit-Linked Productivity Measurement Profit-Linkage Rule: For the current period, calculate the cost of the inputs that would have been used in the absence of any productivity change and compare this cost with the cost of the inputs actually used. The difference in costs is the amount by which profits changed because of productivity changes. To compute the inputs that would have been used (PQ), use the following formula: PQ = Current Output/Base-Period Productivity Ratio

35. 15-35 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profit-Linked Productivity Measurement Example: Tick-Tock Company provided the following data for 2000 and 2001: 20002001 Production (no. of clocks)100120 Selling price$500$500 Materials used (kg.)5072 Labour hours used200228 Cost per kg. of material$5$5 Cost per hr. of labour$10$10

36. 15-36 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profit-Linked Productivity Measurement Compute the profit change attributable to productivity changes. PQ (materials)= 120/2= 60 kgs. PQ (labour)= 120/0.5= 240 hrs. Profit change: Input Mat’ls Labour PQPQ x PAQAQ x P(PQ x P) - (AQ x P) 60 240 $ 300 2,400 $2,700 72 228 $ 360 2,280 $2,640 $ (60) 120 $ 60 Profits have improved by $60 because of productivity changes.

37. 15-37 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Price-Recovery Component and Gainsharing l The difference between the total profit change and the profit-linked productivity change is called the price-recovery component. l Gainsharing is providing to a company’s entire workforce cash incentives that are keyed to quality and productivity gains.