Costs of Non-Quality: How to tip the scale?

The costs associated with non-quality can have a major impact on companies' revenue, and managers have understood this! Fortunately, there are methods, such as the Cost of Obtaining Quality (COQ), to better understand and control these costs.

How to assess these costs? What is it used for?

In 2016, Samsung engaged in a global recall of all Galaxy Note7 mobile phones after multiple reports of battery failure causing overheating and spontaneous explosion. They voluntarily recalled 2.5 million units and lost about $5.3 billion.

Product recall is a drastic and costly measure that no company would want to take. Calculating the cost of poor quality (COPQ) allows organizations to put into perspective the enormous costs associated with the poor performance of products, services, and processes.

It is estimated that organizations have an actual quality-related cost of up to 15 to 20% of sales revenue. In other words, poor products and services cost companies almost a quarter of their revenue. Product failure is an absolute financial loss in the manufacturing sector.

Cost Of Quality (COQ) or Quality Cost

Before we dive into the cost of poor quality, let's look at the big picture and start with the cost of quality (COQ).

Cost of quality is a method of calculating the costs incurred by companies to ensure that products comply with quality standards, plus the costs of producing products that do not meet quality standards. It is a methodology used within organizations to measure the level of resources used for producing good quality products and services. In other words, it is the cost of obtaining quality products or services.

The COQ is oftentimes represented either as a percentage of sales or as total costs. This cost-based approach is a way to facilitate communication and understanding across all of the company's stakeholders (decision-makers, employees, shareholders, etc.).

Thus, the formula for obtaining the COQ is the addition of the cost of good quality and the cost of poor quality:

COQ = Cost Of Good Quality (COGQ) + Cost Of Poor Quality (COPQ)

What is the Cost of Good quality (CoGQ)?

The cost of good quality (CoGQ) is the set of costs related to the conformity of products and services to quality standards. All costs covering control and problem prevention activities are included in these costs. They are classified into 2 cost categories: Assessment costs (CA) and Prevention costs (PC).

Cost of Good quality (CoGQ) = Prevention costs (AC) + Appraisal costs (PC)

Prevention costs

Prevention costs are the costs associated with all quality control activities to prevent failures and eliminate defects. These are planned costs to ensure that nonconformities do not occur at any stage of production (design, development, manufacturing, delivery, etc.)

Prevention costs include:

Compliance of products or services: analysis and determination of specifications of incoming materials (semi-finished products, parts, etc.)
Quality Assurance: Implementation of the process approach (Definition of processes, KPIs, etc.), continuous improvement, document management, etc.
Quality planning: identification of customers (external and internal), identification of customer needs, specification of product/service quality standards, identification of process sequences, etc.
Training: Lessons Learned analysis, preparation, maintenance, etc.

Appraisal costs

Expertise costs are the costs incurred to control, measure, or evaluate the process, product, or service at the various operational stages (from manufacturing to delivery). These are all activities ensuring compliance with predefined specifications.

They include:

Quality control: cost of verifying, reviewing, and auditing processes used, quality control of finished product specifications (sampling test, measurement, etc.), verification of process setup
Internal Quality audits: ensuring that the quality system is functioning correctly
External Quality audits: supplier assessment and approval

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What is the Cost of poor quality (COPQ)?

COPQ is a business metric used by companies worldwide to define the costs associated with producing poor-quality products or services. It is a calculation that determines the costs that would disappear if all failures were removed from a product, service, or process. In other words, the cost of poor quality (COPQ) is a cost that would vanish if the operational part and end product/service were perfect.

These costs are classified into 2 cost categories: Internal Failure Costs (IFC) and External Failure Costs (EFC).

CoPQ is the combination of these 2 different failure costs:

Cost of poor quality (CoPQ) = Internal failure costs (IFC) + External failure costs (EFC)

Internal failure costs

Internal failure costs are the costs associated with identifying defects in the product or service before delivery to the customer. These costs arise when the products/services do not meet the required quality standards.

These costs include:

Scrap: defective product (end product, semi-finished products, parts, etc.) that cannot be repaired, used, or sold
Waste: extra and unnecessary work (repair and rework) caused by poor organization or communication
Rejection during production: rework or rectification (correction of a defective product)
Failure analysis: efforts made to establish the causes of the internal failure of the product or service

External failure costs

External failure costs are the costs associated with defects found by the customer upon receipt of the product or service. These costs arise when end products or services fail to meet design quality standards. This cost category is often difficult to estimate accurately due to its nature.

They could include:

Repairs and maintenance: cost of resolving customer complaints and cost of penalties, lawsuits
Product return and recall: investigation of the quality defect and recalled products, transport costs
Warranty Claims: Product replaced and/or services performed again under warranty
Damage to brand image: loss of customers, loss of reputation

Thus, the cost of quality is obtained by combining these four cost categories:

Figure 1 - Cost Of Quality (COQ) reprsesentation

How can an organization implement this business metric?

Nowadays, more and more companies rely on digitalized management systems to optimize their performance. Indeed, the top benefit (40%) of adopting a Digital Model is operational efficiency improvement. The IoT (Internet of Things) revolution has facilitated the shift to digital for most companies as it now plays a critical role in adding business value.

As more and more data from the operational process are available thanks to IoT (Interconnected device and equipment, sensors,…), companies are gradually investing in AI (Artificial Intelligence) and top business intelligence (BI) platforms. Indeed, 46% of small businesses use BI tools to manage their activity.

The average actual quality cost is 15-20% of sales revenue, for some organizations, it might go as high as 40% of total operations. An effective quality improvement program can progressively reduce this amount. But If an organization wants to make a direct contribution to profits, adopting the Digital Model is the best option as it can reduce the cost of poor quality by 14%.

A couple of decades ago, organizations were often unaware of the huge costs associated with poor quality and poor performance of products and services. In today's world, customers are better informed and have a stage to freely express their opinion. If a company wants to have a chance of surviving and being competitive in today’s market, it must strive to meet customer requirements while reducing the cost of quality.