The Cost of Quality

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THE COST OF QUALITY Managing Operations and the Supply Chain Ho Chi Minh City, 2016 Submitted to: Dr. Andrew Gough MBA Program Cohort 4 Submitted by: Nguyen Ngoc Huyen Tran Student ID: 15422747 Words count: 2749 University of Northampton’s MBA Student

Transcript of The Cost of Quality

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THE COST OF QUALITY June 19, 2016

Student’s ID: 15422747

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THE COST OF

QUALITY Managing Operations and

the Supply Chain

Ho Chi Minh City, 2016

Submitted to: Dr. Andrew Gough

MBA Program Cohort 4

Submitted by: Nguyen Ngoc Huyen Tran

Student ID: 15422747 Words count: 2749

University of Northampton’s MBA Student

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Table of contents

1. Introduction ............................................................................................................. 1

2. Literature review ..................................................................................................... 2

2.1. Total Quality Management............................................................................... 2

2.2. Cost of Quality .................................................................................................. 4

2.2.1. Fundamentals concept .............................................................................. 4

2.2.2. Opportunity cost ........................................................................................ 5

2.2.3. Models of quality costs ............................................................................. 6

3. Critical Review ........................................................................................................ 9

3.1. Failures in quality management: .................................................................... 9

3.2. Discussion ...................................................................................................... 11

4. Conclusion ............................................................................................................ 13

References ................................................................................................................... 15

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1. Introduction

The economy is developing very fast and it is becoming more competitive with each

passing day as customers also become more difficult (Weckenmann and Akkasoglu,

2012). The organization has to face more fierce competitions and challenges every day.

Many companies provide the same products or services for the same customers

(Weckenmann, Akkasoglu and Werner, 2015). To survive on this conjuncture, they must

build up their reputation based on great product quality.

Many foundational principles of quality were introduced and developed by Deming in

1986 (Wicks. A and Roethlein. C, 2009). They had quickly become essential factors in

many companies’ operation. Consequently, quality management must be given more

attention like an important strategy (Khaled Omar and Murgan, 2014). Many authors

think that quality of products or services has a close relationship with customer

satisfaction. In order to help companies control their product quality more efficiently, the

concept of cost of quality (CoQ) was formed and developed continuously.

Quality cost philosophy was first described by Armand V. Feigenbaum (1956) in his

book, “Total quality management”. After that, many modified definitions of CoQ had

appeared. Chiadamrong (2003) said, “The cost of quality is a comprehensive system,

not a piecemeal tool.” According to Chopra and Garg (2012), quality cost is the gap

between actual cost and perfect cost of products or service. In general, quality cost is a

useful methodology that helps companies to build trust with customers, ensure

sustainable development and increase their profit.

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Crandall and Julien (2010) said that The American Society of Quality (ASQ) define

cost of quality as follows: “Quality costs are the total of the cost incurred by investing in

the prevention of nonconformance to requirements, appraising a product or service for

conformance to requirements, and failing to meet requirements. The sum of these costs

represents the difference between the actual cost of a product or service and what the

reduced cost would be if there were no possibility of substandard service, failure of

products or defects in their manufacturing.”

This paper will provide general and in-depth information about costs of quality and

its development up to the present day with two main parts. The first part will concentrate

on concepts, definitions, and models of quality costs as well as how it was formed. The

second part will contain real example, discussion and analysis about how CoQ concept

is as relevant today as it has ever been.

2. Literature review

2.1. Total Quality Management

For the last 100 years, the concept of quality management in organization has

changed significantly (Weckenmann, Akkasoglu and Werner, 2015). Nowadays,

companies have a more comprehensive view about quality management and realize

how it is crucial for their development. Figure 1 summarizes the development history of

quality concept when it has appeared until now. The most recent concept, which is Total

Quality Management (TQM), is very popular in the last ten years. Weckenmann,

Akkasoglu and Werner (2015) pointed out that TQM can be used in any type of

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industries with or without competition like public service, public education, etc.

Figure 1: Overview of concepts in quality management

Sources: (Weckenmann, Akkasoglu and Werner, 2015)

They also believed that every employees of the organization would face many

changes in their responsibility as well as tasks in order to contribute to quality

management when their company chooses to apply TQM. Besides that, many

researchers agree that better quality cost control will lead to an improvement in total

quality as well as company’s business (Khaled Omar and Murgan, 2014).

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2.2. Cost of Quality

2.2.1. Fundamentals concept

Many definitions of cost of quality have appeared in various of studies (Setijono and

Dahlgaard, 2008; Crandall and Julien, 2010; Bangert, 2012; Guinot, Evans and Badar,

2016) since Dr. Joseph Juran first introduce it in 1950. In general, cost of quality is

calculated by this formula below:

Total quality costs = Prevention costs + Appraisal costs + Internal failure costs +

External failure costs = Costs of good quality + Costs of poor quality

Prevention costs are costs that are needed to prevent or avoid product defects and

non-conformance. Appraisal costs are costs that are used to ensure high-quality level in

all steps of the production process. It helps companies to achieve high quality standards

and performance requirements. These costs help to reduce the possibilities of failures

and are called costs of good quality.

Internal failure costs are costs of bad consequences if products or services do not

meet quality requirements. These costs appear before the delivery of products or

services to consumers. External failure costs, happen after the product delivery, are

costs of dealing with problems caused by bad quality products (customer complaint,

recall, etc.). This external failure costs, which are known as cost of poor quality, can

result in loss of customers, loss of trust, customer dissatisfaction, etc. The table below

helps readers to have a clearer overview about different categories of quality costs.

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Table 1: Examples of Categories of Quality Costs

Costs of good quality

Prevention costs Appraisal costs

• Quality planning • Supplier evaluation • New product review • Error proofing • Capability evaluations • Quality improvement team meetings • Quality improvement projects • Quality education and training …

• Checking and testing purchased goods and services • In-process and final inspection/test • Field testing • Product, process or service audits • Calibration of measuring and test equipment …

Costs of poor quality

Internal failure costs External failure costs

• Rework • Delays • Re-designing • Shortages • Failure analysis • Re-testing • Downtime • Material review …

• Complaints • Repairing goods and redoing services • Warranties • Customers return • Environmental costs • Products recall …

Sources: Adopted from Chopra and Garg (2011); Isixsigma.com (2016)

2.2.2. Opportunity cost

The concept of opportunity costs (hidden cost), which w presented in 1998 by

Sandoval - Chavez and Beruvides, had added a new aspect to cost of quality concept.

According to Sailaja, C Basak and G Viswanadhan (2015), opportunity costs are the

losses incurred if the opportunity of doing things right the first time is missed out.

According to Dobrin and Stanciuc (2013), hidden costs are the main contributor to

failure cost. These hidden costs are very difficult to measure (Gary Cockins, 2006).

According to Cheah, Shah and Fauziah (2011), traditional accounting systems cannot

satisfy the demand of finding quality cost, especially hidden costs.

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There are three elements included in this concept - hidden cost: not fully utilizing

available capacity, insufficient handling of materials and substandard provision of

services (Sandoval-Chavez, 1998). The first two components are related to inadequacy

process. They consist of costs of new set-up, extra waiting and idle time, and extra

inventory expenses that are need to respond to bad quality (Omar and Murgan, 2014).

These costs contribute for 40 percent of total opportunity costs while substandard

provision of services is account for the rest 60 percent.

2.2.3. Models of quality costs

There are five generic models of cost of quality: P-A-F model, Crosby model,

Opportunity cost model, Process cost model and ABC model (Khaled Omar and

Murgan, 2014). Table 2 is a summarization about publication history of quality costs

model.

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Table 2: Generic cost models and cost categories

Generic model

Cost/activity categories Examples of publications describing, analyzing or developing the model

P-A-F models Prevention + Appraisal + Failure

Feigenbaum (1956), Purgslove and Dale (1995), Merino (1988), Chang et al. (1996), Sorqvist (1997b), Plunkett and Dale (1988b), Tatikonda and Tatikonda (1996), Bottorff (1997), Israeli and Fisher (1991), Gupta and Campbell (1995), Burgess (1996), Dawes (1989), Sumanth and Arora (1992), Morse (1983), etc.

Crosby’s model

Conformance + Non-conformance Suminsky (1994) and Denton and Kowalski (1988)

Conformance + Non-conformance + Opportunity Tangibles + Intangibles P-A-F (failure cost includes opportunity cost)

Carr (1992) and Malchi and McGurk (2001) Juran et al. (1975) Heagy (1991)

Process cost models

Conformance + Non-conformance Ross (1977), Marsh (1989), Goulden and Rawlins (1995) and Crossfield and Dale (1990)

ABC models Value-added + Non - value-added

Cooper (1988), Cooper and Kaplan (1988), Tsai (1998), Jorgenson and Enkerlin (1992), Dawes and Siff (1993) and Hester (1993)

Sources: Adopted from Schiffauerova and Thomson (2006)

Schiffauerova and Thomson (2006) pointed out that most analysis about cost of

quality use the P-A-F model. Besides that, this model also has been chosen to apply

quality cost model by many companies (Schiffauerova and Thomson, 2006). The P-A-F

model invests resources in appraisal and prevention costs to reduce failure costs; and

after that, it will invest with prevention costs to reduce appraisal costs.

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However, many quality experts often challenge the PAF model. They state their

point that there is no economic level of quality and the optimum quality level is zero

failure (Plunkett and Dale, 1988ab; Fox, 1989). Juran (1998) suggested that in many

cases, the traditional optimal quality level concept is flawed. It supported the idea that

zero defects were not financial effective. The new concept of optimal quality cost

support the option of total perfection in quality. Figure below show the difference

between the classic and the new model of optimal quality cost.

Figure 2: The difference between classic model and modern model of P-A-F

model

Sources: (Schiffauerova and Thomson, 2006)

Crosby’s model was defined by Crosby in 1979. He pointed out the total quality cost

is the sum of conformance costs and non-conformance costs. The cost of conformance

includes actual prevention and appraisal costs, while the cost of non-conformance

corresponds to actual failure costs. Nonetheless, this model is very similar to the P-A-F

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model; the only different is in their names (Goulden and Rawlins, 1995).

As for the new model of process cost, it was introduced by Ross (1977). It focuses

on the quality of the process instead of the quality of final services or goods. This model

was first applied by Marsh (1989) in identifying the cost of quality. This process cost

concept is similar to the model developed by Crosby. It consists of two kinds of costs:

conformance and non-conformance costs. These costs can be calculated at any time

during the production process.

The latest model is Activities Based Costing model (ABC model). Cooper and

Kaplan introduced it in 1988. This model tracks down the costs of all resources and their

corresponding activities and vice versa. After that, it attributes these costs to the final

cost of the products or services. ABC model is in fact not a model of quality cost,

however, but it is a very useful tool in identifying and manage quality costs.

3. Critical Review

3.1. Failures in quality management

Nowadays, the demand of customer is more and more difficult to satisfy. In order to

maintain the development of business, companies must try to produce high quality

products and services. This makes cost of quality becomes extremely important for any

organizations. Because the fact that investing in quality management requires lots of

efforts and resources, many companies still do not want to implement it or implement it

but not very strictly. Nevertheless, in the end, these companies have to pay more to

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deal with their failures.

The failures of several popular companies, showed in the table below, are great

examples of companies that use their quality costs management inefficiently.

Table 2: Example of Inefficient Quality Costs Management

Time Company Events Damage

2006 Dell Recalls 4 million laptops due to faulty over heating batteries

$400 million

2007 Mattel Recalls 19 million toys supplied from China $30 million

2010 Toyota Recalls 9 million cars due to a faulty accelerator pedal

$5.5 billion 52 deaths 38 injuries

2011 UK banks Required to pay compensation for mis-selling of Payment Protection Insurance

£40 billion +

2014 Corona Beer Recalls 1% products on the market that that may contain small pieces of glass

~ $37 million

2015 Alton Tower Rollercoaster crash results in compensation claims and less customer visits

£40 million + 16 injuries

Sources: (International Business Times, 2016; YouTube, 2016)

If companies do not concentrate on quality management, damages will be serious. It

is not only about money, but also about environment and human life. There are many

reasons lead to failure such as: underestimate the importance of quality control, poor

leadership and management, lack of employees’ involvement, employees resistance to

change, etc.

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When the companies do not manage their quality effectively, the cost of dealing with

consequences is enormous. Besides paying the cost in cash, companies will face to

intangible cost and other challenges such as loss of customers’ loyalty, bad business

reputation, and higher turnover rate due to employees do not feel proud about their

company, etc.

Nowadays, there are more and more companies that choose to apply costs of

quality management, especially large companies. Many companies such as General

Electric, Hewllet – Packard, Coca – Cola, 3M, Ikea… have their own quality

management system as well as quality cost control program. Although the investment in

prevention and appraisal costs is quite expensive, the benefits and positive effects of it

are far greater than that.

3.2. Discussion

In the increasingly competitive market, many companies try to increase their profits

by cutting down costs (Douglas, 2009; Young, 2009). Nonetheless, cost cutting is a

tricky problem that might affect the company’s sustainable development (Warren, 2009).

Beside other quality control methods, cost of quality model is an appropriate solution

that helps companies to improve their overall quality by controlling cost factors (Malik et

al., 2016).

The objective of quality costs is not only to reduce the costs but also to find the

optimal level of quality and cost factor that maximize profits. As Schiffauerova and

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Thomson (2006) said: “The objective of a Cost of Quality system is to find the level of

quality that minimizes total Cost of Quality.”

Nevertheless, costs of quality concept are not as popular as some would believe;

only a small number of companies use it (Sower et al., 2007). In reality, measuring

quality costs is a big challenge (Academia.edu, 2016); therefore, companies have a

tendency to choose another methodology to control the quality of their products or

services. Besides, identifying quality costs and using the information provided by it

effectively are two different things. It depends on ability of planning and management of

companies’ top managers.

In facts, there are some special circumstances that a company should not (or

cannot) apply costs of quality method. According to Mike Collins (2015), there are at

least four types of manufacturer based on their sizes: micro size, small size, midsize,

and giant size. As for CoQ concept, he believes that: “One solution will not fit for all.” In

the author’s opinion, quality costs system will have maximum effect if applied in giant

size companies. Other types of companies can still apply this method. However, the

costs of implementing CoQ can be bigger than the benefits those companies get in

return. Besides, there are still many success stories of companies that do not use CoQ

concept but other quality management method (Schiffauerova and Thomson, 2006).

Costs of quality appear in every step of the company’s process; therefore, each

employee is responsible to ensure quality of products or services. However, if the

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concept of this methodology just has spreading inside management team, other

employees will be lack of knowledge and management support to apply it into their job.

It also depends on a culture and different internal systems of organizations as Philip

Crosby once said: “Quality is the result of a carefully constructed cultural environment.”

4. Conclusion

According to Sedevich Fons (2012), quality management is most effective when

being applied in manufacturing firm since it was built in that environment. However, after

many years, many companies have begun to pay attention to solve quality problems

and improve the production process. Nowadays, during the second half of the twenty-

first century, CoQ concept as well as other quality management program is not only

used in manufacturing but also other industries like services, public sectors, etc.

The development of TQM brings lots of innovates and evolutions to the traditional

CoQ concept. In the past, quality cost look into prevention and appraisal cost for short-

term production; but now it has a tendency to concentrate on sustainable development

of companies in long-term. The use of a quality cost system is suggested as a preferred

method with the goal is to reduce quality costs and to achieve the lowest practical level.

Nonetheless, quality cost is not the only quality method that are able to bring

success to the company. The users of this tool are required to consider many

alternative elements such as the size of companies, cultural change or different internal

system, etc. Finally, since quality is a habit not a single act, companies, and its leaders

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should start to look into this quality management concept and started to implement it.

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