Research Articles

Value and the Cost of Quality

Value and the Cost of Quality in most firms is calculated by cost accounting and has been an important function until the integration of LEAN.  All organizations measure and report costs as a basis for control, compliance, and improvement. In this era of heavy oversight and regulation of publicly traded companies, which have to comply with new regulations, the identification of cost related activities is even more important.

The concept of the cost of quality emerged in the 1950s. Traditionally, the reporting of quality related costs has been the focus on inspection and testing. Other costs that were associated with quality were allocated to overhead accounts and were lost in this bundle of cost.

As managers began to identify and isolate the full range of quality related costs, some surprising facts emerged.

  1. Quality related costs were much larger than expected. In many cases they ranged from 20 to 40% of sales or budget.
  2. Quality costs were not only related to manufacturing operations, but also to other supporting services such as procurement, logistics, systems and customer service.
  3. Most of the costs resulted from poor quality and were avoidable.
  4. While the cost of poor quality was avoidable, no clear responsibility for action to reduce them was assigned, nor was any structured approach used to do so.

As a result many organizations began to develop cost quality programs. The cost quality, or more specifically, the cost of poor quality, was associated with avoiding poor quality or were incurred as a result of poor quality.

Types of Costs

The cost of quality approaches has a number of different objectives. Perhaps the most important is to translate quality problems into a language that upper management can understand; this is the language of money. Joseph Juran, one of our most respected quality teachers, proposed that if management was expected to support quality improvement, it needed to make economic sense. Business analysts who must interface with staff, supervisors, as well as top management must have the ability to speak the economics. Another purpose the cost of quality information can serve is to help management evaluate the relative importance of quality problems and identify opportunities for cost reduction. They can also aid in budgeting and cost control activities. Finally, it can serve as a scoreboard to evaluate the organizations success in achieving quality objectives.

Typically, the cost quality is organized into four major categories; prevention costs, appraisal costs, internal failure costs, and external failure costs.

Prevention costs are investments made to keep nonconforming products or results from occurring and reaching the customer.

These costs include such things as:

  • Quality planning costs such as salaries of individuals associated with quality planning and problem-solving teams, this may include the costs of business analysts in the organization. The development of new procedures, new designs, and reliability studies would also be in this category.
  • Process control costs include cost spent on analyzing production processes and implementing process control plans.
  • Information systems costs expended to develop data requirements and measurements
  • Training and general management costs include internal and external training programs, clerical staff expense, equipment and supplies.

Appraisal costs are those associated with efforts to ensure conformance to requirements, generally this is through measurement and analysis of data to detect nonconformance. These costs may include:

  • Test and inspection costs associated with design, code, or systems testing. This would include the labor costs and any associated lab or equipment costs.
  • Lab or equipment maintenance costs arising from the maintenance, calibration or repair of equipment that is used for testing.
  • Process measurement and control costs which involve the time spent by business analysts to gather and analyze quality measurements

Internal failure costs are incurred as a result of poor quality found before the delivery of the product to the customer. Some examples include:

  • scrap and rework costs, including material, labor, and overhead
  • Cost of corrective action, arising from time spent determining the cause of failure and correcting those problems.
  • Process failure costs such as unplanned downtime or unplanned equipment repair.

External failure costs occur after poor quality products reach the customer, specifically rework on systems defects including the cost to repair or reconfigure, and systems downtime, staff travel to customer locations to affect repairs, regression testing, or loss of revenue due to systems downtime.

Experts estimate that 60 to 90% of total quality costs are the result of internal and external failure and are the responsibility of management. A common approach to react to high failure costs is to increase inspection, however this only increases appraisal cost.

 

If the overall reduction of quality costs is not significantly improved, the best practice is to increase prevention which usually generates larger savings in the overall cost of quality. In a typical scenario, the cost of replacing a poor quality component in the field might be $500, the cost of replacement after assembly might be $50, the cost of testing and replacement during assembly might be five dollars, and the cost of changing the design to avoid the problem in the first place might be only $.50. Thus the concept of prediction and prevention over inspection and reaction has proven to be extremely cost-effective.

Better prevention of poor quality clearly reduces internal failure costs as fewer defects are made and external failure costs also decrease. In addition, less testing is required because the systems are designed correctly the first time.

The nature of quality costs differ between service and manufacturing organizations. In manufacturing, quality costs are primarily product related. Services are generally labor dependent because labor often accounts for as much as 75% of total cost. Traditional external failure cost such as warranty and field support are less relevant to services. Process related costs, such as customer service and complaint handling staff and loss customers are more critical. Downtime of systems either partial or total can be the most expensive external failure costs in a service environment. Internal failure costs tend to be much lower for service organizations with high customer contact, which have little opportunity to correct an error before it reaches the customer. By that time, the error becomes an external failure.

Let’s put this all in perspective to the work of the Business Analyst. Usually at a minimum the business analysts will be conducting elicitation of requirements, analysis and solution assessment and validation.

The Business Analyst also may be involved in enterprise analysis, requirements management and communications and business analysis planning and monitoring. Their capability to complete these tasks in a quality fashion contributes greatly to the overall success of the endeavor or the project. Many times unrealistic deadlines, limited resources, or lack of management support result in poor identification and analysis of requirements which lead to ineffective solutions, poor decisions, and systems wracked with errors in design and coding. The obvious result would be rework leading to schedule delays and cost overruns.

How can the business analysts shift the quality costs from the failure category to the prevention category?

More effective up front planning is the single most important way to accomplish this. An investment in a requirements work plan that identifies the work that needs to be accomplished, the resources that will be required to accomplish the work and the schedule for these resources is a very powerful quality tool. One of the challenges the business analysts may face is the cost and time that is involved in developing better plan. Here is where return on quality can be used to justify the additional cost and time.

What are some things that the business analyst can do to gain management support for the investing in quality?

  • Start with an effective quality approach. Utilizing best practices as they are contained in models such as the business analyst body of knowledge are proven ways to produce better results.
  • Calculate the cost of these new or different quality initiatives. Cost of planning, problem prevention, establishing measurements, validation and verification, and stakeholder communications should be broken out as specific prevention costs. We can then measure these against the returns of delivering a better product or service.
  • Determine what key factors enhance stakeholder relationships and what other factors drive them away. Relating needs to quality tasks shows management how these investments in quality can also increase collaboration and communications with the stakeholder community.
  • Focus on those quality efforts most likely to improve results at a reasonable cost. As we start to shift from inspection to prevention there should be a link between each dollar spent on quality and its effect on the project outcomes. For example, we can plan to spend more time and effort in areas such as brainstorming activities, producing dataflow diagrams, additional interviews with stakeholders, more document analysis, requirements workshops, or more use of use of scenarios and use cases. This small step approach many times is more accepted by management than the Big Bang approach. It also allows us to develop competencies in these areas and look for ways to improve.

Conclusion

 

The nature of quality costs differ between service and manufacturing organizations. In manufacturing, quality costs are primarily product related. Services are generally labor dependent because labor often accounts for as much as 75% of total cost. Traditional external failure cost such as warranty and field support are less relevant to services. Process related costs, such as customer service and complaint handling staff and loss customers are more critical. Downtime of systems either partial or total can be the most expensive external failure costs in a service environment. Internal failure costs tend to be much lower for service organizations with high customer contact, which have little opportunity to correct an error before it reaches the customer. By that time, the error becomes an external failure.

Written by Jeff Stempien, PMP, PMI-RMP, PMI-ACP, CBAP, CSM, CSPO

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