THE COST OF QUALITY

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THE COST OF QUALITY

INTRODUCTION
A manufacturer stays in business only as long as his product quality satisfies his customers at the price they are prepared to pay.
Failure to maintain an adequate quality standard can therefore be disastrous. But maintaining an adequate standard of quality also costs effort. From the first investigation to find out what the potential customer for a new product really wants, through the processes of design, specification, controlled manufacture and sale, to the arrangements for aftersales service to the customer, effort is being spent on ensuring that the company's product - and reputation - are good. If it is spent wisely, it can result in savings greater than the increase in costs, and hence in an improvement to profits.
As products become more and more complex, and as customers - both Government Departments and individuals - become more conscious of the effects on their own economics of receiving a proportion of defective items, the effort required must continually increase.
The costs represented by this effort can be a significant proportion of the products sales value (Do you know what the total is in your Company? In some instances the cost of scrap, rework and inspection costs alone has been found to be as high as 20% of turn-over) and any manufacturer should be interested in making sure that he is getting good value for his expenditure. He cannot feel sure unless he has studied what the costs are, how they are incurred and what they ought to be. If they are higher than they should be, he must consider ways in which they can be reduced.
Here we describe the nature of the costs incurred in ring product quality and reliability and shows how costs can be reduced whilst quality and reliability are maintained or improved.
THE NATURE OF QUALITY COSTS
Quality costs fall naturally into three main groups. First there are Costs associated with attaining or setting an adequate quality standard, sometimes called Prevention Costs. They are incurred largely in advance of production, when the quality standard is set. Insufficient money spent at this stage on, for example, design and development may well give rise to unnecessarily high costs later.
The second group is costs associated with maintaining an adequate quality standard, sometimes called Appraisal Costs. These are the costs associated with keeping the work manufacturing and buying functions up to the quality specified in the design.
The third category covers Failure Costs, or the costs associated with putting right any departure from standard. These include the costs of scrap, reprocessing, and guarantee claims. They are the costs, which arise as a result of shortcomings in, or insufficient expenditure on, the other two phases. They may be caused on the one hand by poor design, poor product engineering, poor operative training or, on the other, by bad workmanship, or slipshod inspection at the appraisal stage.
A list of the types of cost connected with quality and reliability will be found in the Appendix. Some difficulty may well be experienced in separating costs associated with quality and reliability from those more directly concerned with achieving the function of the product, for example, design and development. It is more important to recognise the changes deliberately made in these costs as action is taken to bring quality under control.
THE ATTACK ON COSTS
Obviously, the most significant improvements will usually be achieved by concentrating effort on the areas of high cost. For this purpose an analysis of the principal costs is required. Studies have shown that a fairly typical ratio between the three main groups of costs in a manufacturing company is: -

Prevention Costs 5%

Appraisal Costs 30%

Failure Costs - 65%

Failure Costs, because they are typically the largest, will usually give the largest return for the effort involved in reducing them. An effective way of attacking Failure Costs is through a temporary increase in prevention and appraisal costs.
Appraisal Costs - for example, the cost of production and inspection - might be reduced by more attention to Value Engineering, which would to some extent increase prevention costs, and a closer control of the manufacturing process, which would increase appraisal costs.
Appraisal Costs will usually be the next to come under attack. An analysis of all essential quality control operations will often show opportunities for reducing expenditure without reducing effectiveness. For example, statistical sampling techniques may be used as a means of control, indicating trends in performance and assisting to maintain quality. By improving the control of the process, 100 per cent inspection may no longer be necessary.
Total costs will be lowest when design staff are aware of the cost implications of their work. Good design saves cost not only at the design stage itself but throughout production and testing: products become easier to make "right first time". Good design is needed not only when conceiving the product but also when conceiving systems for production and quality control. After failure and appraisal costs have been reduced by attention to the prevention aspect, it may be possible to reduce prevention costs as well.
We have seen that the process of reducing failure costs may well involve increasing expenditure on the design, developing, testing, manufacturing and inspecting processes. However, there must clearly be a point beyond which it would be uneconomic to incur additional expense. Failure costs might possibly be eliminated but at considerable, possibly prohibitive, costs in other areas. There is a point at which the aggregate of all costs is at a minimum for the intended selling price. Achieving this minimum cost will involve reviewing product designs, and improving planning processes, facilities and methods.
When the initial attack on costs has been successful, it will be logical to provide a means for analysing costs and for reporting on them in order to keep a close watch on progress so that, firstly, a worthwhile reduction in the attacked cost is achieved; and secondly, the expected increase in other costs is not exceeded.
SETTING STANDARDS OF COST
This can be done by setting a standard or budget for each cost item affected by the action, and by comparing periodically the actual cost with the standard. Differences between standard and actual cost are then notified to appropriate executives who can modify the tactics of the attack as necessary to ensure that the differences are reduced or eliminated.
Standards may be of two kinds: -

• They may be set on the basis of the calculations made during the preliminary study. In this case, they will be agreed, by the quality controller, with all the executives responsible for ensuring that the study expectations will be realised.
• They may be set by the more-or-less arbitrary decision of top management to reduce overall quality costs by - say - 5% or 10%.

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In a company where executives are properly trained and motivated, the first type of standard is likely to be the more effective. Once the initial expectations have been met, further efforts can be planned and new standards set to correspond.
Improvement comes to be regarded as a normal and continuing process.
In companies where executives lack these qualities it may be preferable to adopt the second type of standard, in which a programme for improvement is autocratically imposed. Active follow-up by a strong personality is characteristically necessary in this situation, to see that executives really do all that is needful.
Standards will usually be set under conditions, which assume a certain volume of throughput and a certain level of incoming quality. If either of these factors changes significantly, the level and balance of costs will probably change also, and standards will need to be adjusted to suit the new conditions.
ASCERTAINING QUALITY COSTS
Cost data will have been required when the first study was made to determine the cost items most open to attack. These data will probably have been derived by ad hoc investigation and analysis. The same figures will have been used to derive standards or budgets.
When costs are to be ascertained regularly for comparison with standards, however, a number of steps are involved. First, it is necessary to decide which costs are to be analysed on a regular routine basis, which are to be analysed less frequently, and which will continue to be derived by special cost studies, or sampling cost methods.
The second step is to decide who is to make each analysis. The preference depends largely upon the source of the information. If the details can be made available from the accounting system the Cost Accountant will logically take on the task. However, if the information is of a technical nature or requires to be extracted from the records of Quality Control or other staff, it may be convenient to have it done by these departments.
Next a system of cost coding to simplify analysis must be provided. Where a code system is already in use it may require modifying to enable quality control costs to be collected in the most meaningful form. It is important that the causes of faults should be revealed and this may necessitate identification of the machine, operator or process where the loss arose.
Finally, one must define the procedure to be followed and the responsibilities of all the affected staff.
CONTROLLING COSTS
The only purpose of reporting costs is to provoke action. Without action the money spent on deriving and reporting data is wasted.
Action is required whenever there is a significant difference between an actual cost and the budget set for it. Action is also required to discover the reason for the difference and to eliminate it. If cost reports are to be effective in provoking this type of action they must be: -

[/table] - presented at suitably short intervals - presented quickly following the period they represent - presented in simple, direct, intelligible form - presented to the people who have the authority and knowledge to act effectively.

It is often effective for reports to be sent both to the person who is expected to take action and also to his immediate superior.

It is important to remember that the actual costs revealed by control reports are the result of joint action by quality control staff and by the design or manufacturing functions. Action to correct undesirable trends may therefore have to be taken by all these groups in co-operation. Action by any one group may well be fruitless.

REPORTING COSTS

Effective quality cost control depends upon good cost reporting.

The cost reporting system should:

[table=98%]- identify the areas of expense, which are being reported

- show actual expenditure compared with that planned

- facilitate the comparison of benefits with the price that is being paid for them

- indicate the causes of excessive costs so that further investigations can be made and corrective action taken.

The data from which the Cost Reports are compiled should be so organised that such further investigations into specific excesses can proceed logically and without the need for too much re-analysis of basic documents.
Reports commonly take one of three main forms, corresponding to the main divisions of Quality Costs. The first is the Failure Cost Report. It is not usually difficult to produce adequate regular reports showing the level of failure costs - scrap, repairs, test rejections, after-sales service, customer returns etc. The essential data they should show includes the cause of failure, the value lost, and the department or process responsible (not necessarily the same, of course, as the department or process at which the failure was discovered and reported).
Supporting data for this report may include reporting point, description of product, part etc., and the responsible machine group or operative. Such supporting data is, however, probably best left out of reports for executive action. It may be more valuable in daily, un-costed, reports for information and action at "shop-floor" level.
The second type is the Appraisal Cost Report. This reflects the cost of operating the quality and reliability surveillance, as compared with budgeted expenditure. The division of account headings may sometimes make it difficult to include the cost of quality appraisal costs incurred by production operatives carrying out additional operations such as the inspection, testing, or grading of pieceparts, but such costs can sometimes be derived from a comparison of actual and standard times for the tasks, and included in a separate section of the report.
Finally, a Prevention Cost Report is required. So many functions of the typical business can be interpreted as contributing to Prevention Costs that it is normally wise to restrict reports to those areas which are being deliberately varied as part of the overall cost reduction project. The scope of such ad hoc reports can be enlarged to include data from which changes in Quality tactics can be planned. Such reports might include: an analysis of the effects on profits of changes in the system of setting manufacturing tolerances; the probable cost effects of introducing a Vendor Rating scheme; recommendations on the most economical points for inspection in a sequence of operations; and an investigation into the economics of buying new testing facilities.
Note that in studies involving a choice of methods we are concerned with the change in profit resulting from the decision - that is the difference in the profit-and-loss accounts before and after adopting the change. The costs which we use for studies of this nature are not likely to be the same as those used for normal cost accounting, for which purpose we have become used to the convention of expressing overheads as a percentage of - say - direct labour. This approach is unsuitable for finding the real cost, or change in cost, since in most cases the choice will cause little change in the fixed part of overhead costs, such as establishment and management expenses.
RECOMMENDATIONS
Here are ten steps that can be taken to reduce Quality Costs in your company:

• Find out what Failure Costs are. The cost headings to include are listed in the Appendix
• Decide, from the size of these preventable Failure Costs, the scale of extra quality control effort devoted to prevention and Appraisal which can be justified.
• Nominate a senior member of the organisation to have responsibility for quality control. He should be familiar with and able to lead and train his staff in all aspects of quality control
• Obtain from this manager a list of actions which can be taken, in the particular circumstances of your organisation, to reduce systematically your Failure Costs
• Evaluate the approximate probable benefit of each action in reducing Failure Costs e.g. by how much will the customer guarantee claims be reduced? How large a reduction in scrap can be expected from Room "X"?
• Evaluate the approximate probable cost of each of these actions separately, e.g. what will extra design administration cost? How much will have to be spent on new test gear?
• Choose the one or two actions which are seen to offer the probability of largest return for the cost to be incurred
• Make the quality controller responsible for seeing that these actions are taken and that the forecast benefits are actually secured:-

• Don't give him too much to do at one time
• Give him a firm date for completion: make it tight but not impossible
• Make sure he follows up each action and keeps it going
• Insist on regular reporting of progress in cost terms - but don't interfere with the authority that you have delegated to him

• As benefits are seen to flow from the first few - actions, initiate a few more from the original list - and insist that extra possibilities are constantly added to the list so that the process never comes to an end
• Find out what the Appraisal Costs are and, in an exactly similar way, initiate actions designed to reduce specific Appraisal Costs by improving Prevention activities.

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dilly

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