Cost of Poor Quality

Before we could start discussing anything, let me forewarn you that this article is going to be a long one, so take some time off your busy schedules reading it. As the title says, Cost of Poor Quality it is; a term that is misconstrued badly in the Six Sigma fraternity. In fact the term Cost of Poor Quality (referred to hereafter as COPQ), is used so commonly even in Non-Six Sigma companies that this often deserves more than a merit or a discussion.

I also duly acknowledge the contribution of Dr Joseph Juran and his The Quality Handbook, which helped me compose this article.

Simple things first --- COPQ is the cost or price a company pays when all of its products are not perfect. In other words, COPQ would go away completely if the products are made perfectly and without any need to rework them whatsoever. So, in simple words, COPQ is a possible loss and we are looking up to companies to avoid this possible loss to them.

Can COPQ be avoided completely?

Ignorance to this concept could lead most to ambitiously proclaim, “I would want to reduce my COPQ to 0” Lovely thoughts and as the concept of COPQ is unravelled to you slowly, you may say it is possible. But practically, it is like scaling the Great Wall of China on the back of an old turtle. You know you would get there, but how much time --- God knows! Companies may not be able to live with such uncertainty especially when it comes to costs and timelines.

COPQ is

The summation of three different costs

• Costs of non-conformities
• Cost of inefficient processes
• Cost of lost opportunities for sales

You would find a lot of companies referring to the same concept as Economics of Quality and that is absolutely fine. It is just a difference in the way how the concept is termed and used.

COPQ as used in companies

Companies prefer categorizing COPQ in four different categories and until date, this is the best way how COPQ could be broken down

• Internal Failure Cost
• External Failure Cost
• Prevention Cost
• Appraisal Cost

Internal Failure Cost

These costs are due to deficiencies discovered before delivery of the product, with the product not being able to meet stated and perceived needs of the customer. These costs also include process inefficiencies and process losses (See rework) even if the customer needs are met.

• Failure to meet customer needs --- Examples are Downgrading, scrap and rework
• Inefficient processes --- Unplanned downtime, variability of product characteristics, Difference from benchmarked products

External Failure Cost

These costs are associated with deficiencies found after product is delivered to the customer. This cost will also factor in costs due to missed sales. How? For example, you shipped 100 pens to the customer and the customer reports 10 pens defective. Chances are --- He wouldn’t pay for these 10 pens. Assume price per pen is $5. Means $50 lost due missed sales and this is nothing but an external failure cost for the company!

• Failure to meet customer needs --- Warranty
• Cost due lost sales --- Customer Defectives

Appraisal Cost

These are costs associated/incurred to meet the degree of conformance or determine the degree of conformance to customer requirements. You normally associate appraisal costs with inspections, audits, and evaluation of stocks.

In collecting appraisal costs, what is decisive is the kind of work done and not the department name (the work may be done by chemists in the laboratory, by sorters in Operations, by testers in Inspection, or by an external firm engaged for the purpose of testing). Also note that industries use a variety of terms for “appraisal,” e.g., checking, balancing, reconciliation, review.

Prevention Cost

Prevention costs are incurred to keep the Appraisal and Failure Costs to a bare minimum. Goes to show that appraisal and failure costs are often treated as direct indicators of how inefficient the process could be, in terms of passing defects on! Obviously no business would like to pass defects to the customer and that’s why Prevention costs kick in.

The compilation of prevention costs is initially important because it highlights the small investment made in prevention activities and suggests the potential for an increase in prevention costs with the aim of reducing failure costs.

Experience also suggests, however, that continuing measurement of prevention costs can usually be excluded in order to (1) focus on the major opportunity, i.e., failure costs, and (2) avoid the time spent discussing what should be counted as prevention costs.

This part of the section focuses on the question “How much is it costing our organization by not doing a good job on quality?” Thus we will use the term “cost of poor quality.” Most (but not all) of the total of the four categories is the cost of poor quality (clearly, prevention costs are not a cost of poor quality.) Strictly defined, the cost of poor quality is the sum of internal and external failure costs categories. But this assumes that those elements of appraisal costs—e.g., 100 percent sorting inspection or review—necessitated by inadequate processes are classified under internal failures. This emphasis on the cost of poor quality is related to a later focus in the section, i.e., quality improvement, rather than just quality cost measurement.

An example

A table shown below has COPQ calculated for a nuts and bolts manufacturing company

Okay, so the grand COPQ as on date is about $800,000, and as we can see, Failure costs contribute the most to the Cost of Quality (About 53%). Now, the prevention costs, which normally should be a bit high to offset the failure costs, are seen at a low of about 1.2%. More focus is needed on part of the company to install preventive mechanisms so that the failure costs are reduced.

Key COPQ Analysis

Failure costs are way too high and prevention costs are way too low. The company needs to invest more in preventive activities, which is thought of as an effective way to reduce Failure costs.

The key categories are the failure cost elements because these provide the major opportunity for reduction in costs and for removal of the causes of customer dissatisfaction. These costs should be attacked first. Appraisal costs are also an area for reduction, especially if the causes of the failures are identified and removed so as to reduce the need for appraisal.

Hidden Costs

It is the worst nightmare for any OPEX guy or a Project Manager. While the COPQ categorization of different costs is elaborate enough to cover all the costs associated with poor quality products, hidden costs is something that doesn’t figure in any list. Some, and not all, of the hidden cost titles are summarized below

• Cost of redesign poor quality products
• Cost of changing the process due to non-adherence to customer requirements
• Cost of Software changes
• Cost of downtime
• Extra indirect charges included (Space charges)
• Cost of errors in support processes and not really the core processes

COPQ interpretations

• The failure costs: These equal zero when the product is 100 per cent good, and rise to infinity when the product is 100 per cent defective. The target thus for the business is to maintain their defective goods at a minimum level, which would mean that the failure costs, a summation of internal and external failure costs, are always at a minimum.

• Appraisal and Prevention Costs: These costs would be the lowest when 100% goods are defective (Note how they work exact the opposite of Failure costs), and would be the highest for all the products to be perfect.  Makes logical sense, doesn’t it? If your process has a very low percentage of prevention costs, it means you have not installed enough preventive mechanisms, and it obviously means, the chances of a defect to go through is really high. Same logic applies to appraisal costs as well!

COPQ – A summary

• COPQ or COQ, Cost of Quality, is not the cost of producing Good quality products, which may be the first confusion for a lot of people when they hear about this term. It is actually the price incurred by the company in making poor quality products.

• COPQ is broadly categorized into three costs – 1) Due non-conformities, 2) Due lost sales and 3) Due inefficient processes. When companies refer to these costs, they’d stick with these categories or look at four categories --- Internal Failure Cost, External Failure Cost, Appraisal Cost and Prevention Cost.

• Internal Failure Costs are costs incurred in pre-delivery non-conformities or poor processes. External Failure Costs are costs incurred in post-delivery non-conformities or lost sales.

• Every company should decidedly try to reduce the failure costs, which more often than not, makes up for a huge amount in the end COPQ figure.  High prevention costs may not really worry the company a lot especially if the failure costs are low, but a call on the prevention costs would be taken by the top leadership of the company.