Cost of Poor Quality: Definition, Types, Benefits and Examples

What Is the Cost of Poor Quality?

The cost of poor quality can be high and far-reaching. Poor quality can impact a company's bottom line through increased expenses associated with rework, scrap, and warranty claims. In addition, poor quality can damage a company's reputation and lead to lost customers and revenue. 

The cost of poor quality is the difference between the expected costs of a product or service and the actual costs incurred. The cost of poor quality can be divided into four major categories:

• Prevention costs: Prevention costs are the costs incurred to prevent poor quality from occurring in the first place. 

Examples of prevention costs include quality control and inspection costs.

• Appraisal costs: Appraisal costs are incurred to identify poor quality after it has already occurred. 

Appraisal costs include testing and inspection costs.

• Internal failure costs: Internal failure is incurred when poor quality is identified before it is delivered to the customer.

Internal failure costs include the costs of rework, scrap, and defects.

• External failure costs: External failure costs are incurred when poor quality is delivered to the customer. 

External failure costs include the costs of warranty claims, customer returns, and lost sales.

The cost of poor quality can have a significant impact on a company's bottom line. In some industries, the cost of poor quality can be as high as 20% of total revenue. For companies struggling to compete, the cost of poor quality can be a death knell.

Why Cost of Poor Quality (COPQ)

• COPQ is a financial measure that captures the cost of poor quality in a manufacturing or service organization. It includes all costs associated with producing or delivering a product or service that does not meet the required quality standards. 
• COPQ is often used as a metric to assess the effectiveness of quality improvement initiatives. By tracking COPQ over time, organizations can gauge the impact of quality initiatives on overall cost and profitability. 
• Several factors can contribute to high COPQ, including defects, rework, scrap, and customer returns. In many cases, the root cause of high COPQ is poor processes or lack of process control. 

Addressing high COPQ can be a challenge, but there are some strategies that organizations can use to reduce it. These include process improvement, Six Sigma, and lean manufacturing.

When to Use Cost of Poor Quality (COPQ)

COPQ is a quality metric that can help determine when quality issues cost a company money. By tracking COPQ, businesses can decide when to invest in quality improvement efforts. 

For example, if a company is seeing a high COPQ, it may be indicative of a need to invest in better quality control measures. 

Additionally, COPQ can be used to benchmark against other companies in the same industry to see how well a company is performing in terms of quality.

Steps in Implementing Cost of Poor Quality (COPQ)

A few steps need to be followed when implementing a Cost of Poor Quality (COPQ) plan. 

• First, you need to identify all of the potential costs that could be associated with poor quality, which includes things like scrap, rework, and warranty claims. 
• Next, you need to track and monitor these costs to get a good idea of the problem areas. Once you understand the problems, you can start working on ways to reduce or eliminate them, which might involve process changes, training for employees, or other corrective action. 
• Finally, you need to periodically review the COPQ plan to ensure it is still effective and make any necessary adjustments.

Contextualizing the Cost of Poor Quality

There are many factors to consider when contextualizing the cost of poor quality.

• Poor quality can lead to increased costs in rework, warranty claims, and customer churn, and it can also lead to decreased productivity and profitability. To fully understand the cost of poor quality, it is essential to consider all these factors.
• Rework, and warranty claims are often the most direct and tangible costs of poor quality. Rework can be costly in terms of time and money, and warranty claims can eat into profits. In addition, poor quality can lead to decreased productivity, and this can be due to employee downtime, lost materials, and scrap. 
• Finally, poor quality can lead to customer churn, which can be costly in terms of both lost revenue and decreased brand reputation.

When considering the cost of poor quality, it is essential to consider all of these factors. By doing so, organizations can be better equipped to address the issue and minimize the negative impact of poor quality.

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.

Example of Cost of Poor Quality (COPQ)

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.

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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.

That being said, reducing failure costs would always mean investing more on the prevention costs. Is the organization ready for it?

• 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.

At the end of the day, the COPQ number is merely a reflection of the quality of your processes and quality of your products and should be treated that way!

Benefits of Attending to COPQ 

You can gain more benefits from attending the COPQ. For example, COPQ can help organizations to improve their competitiveness. By improving processes and quality, organizations can become more efficient and improve their overall competitiveness. And also, you can gain more benefits of reduced cost, reduced time, and customer satisfaction by attending COPQ.

Reduce total cost

One of the most important benefits is that it can help organizations reduce total costs. By reducing waste and improving processes, organizations can achieve significant cost savings. 

Reduce lead time

One of the benefits of reducing COPQ is that it can lead to reduced lead times. This benefit is because addressing waste sources can help improve process efficiency and quality, which can, in turn, help reduce cycle times. In some cases, reducing lead time can also improve quality, allowing more time to be spent on quality control. 

Satisfied customers

An additional benefit is customer satisfaction. COPQ can help organizations to improve quality and customer satisfaction. Organizations can improve the quality of their products and services by reducing defects and improving customer service. 

Disadvantages of Cost of Poor Quality (COPQ)

There are several disadvantages to using the Cost of Poor Quality (COPQ) metric. 

• It can be difficult to accurately quantify the cost of poor quality, as it can include both direct and indirect costs. 
• COPQ focuses on defects' costs rather than the root causes. As a result, COPQ can lead to a blame game, with each department trying to shift the blame for defects to another department. 
• And COPQ can be used as a justification for cutting corners and reducing quality rather than as a tool to improve quality.

IT Sprawl As a Real Phenomenon

There is no question that IT sprawl is a real phenomenon. The cost of poor quality (COPQ) directly results from this sprawl. When organizations allow their IT infrastructure to grow unchecked, they effectively increase the amount of money they are wasting. This is because COPQ is often the result of inefficiencies and errors in the IT system. When an organization has to spend more money to fix these problems, it wastes money that could be used more efficiently elsewhere.

In addition to the direct costs associated with COPQ, IT sprawl can lead to indirect costs. For example, if an organization's IT infrastructure is poorly managed, it can lead to disruptions in business operations, ultimately leading to lost revenue and customers.

Thus, it is clear that IT sprawl is a real phenomenon with real costs. Organizations need to be aware of these costs and take steps to avoid them. One way to do this is to invest in quality management systems that can help to identify and fix problems before they lead to costly disruptions.

Improving the Accuracy of Data Tied to the Cost of Poor Quality

Many factors can contribute to data accuracy tied to the cost of poor quality. 

• To improve the accuracy of this data, businesses should first identify and track the root causes of errors and defects. They should then put processes and controls in place to prevent these errors and blemishes. Finally, they should continuously monitor and improve these processes and controls to ensure that the data remains accurate.
• Businesses can improve the accuracy of data tied to the cost of poor quality by taking a proactive approach to identifying and addressing errors and defects. By tracking the root causes of errors and defects, businesses can implement processes and controls to prevent them from occurring. And by continuously monitoring and improving these processes and controls, companies can ensure that the data remains accurate.

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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.

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