The Cost of Quality

Every organization thinks about the quality of the goods and services they produce. After all, their name is on the line. Not all companies, however, pay attention to the money they’re spending to reach that level of quality. On average, a company’s total cost of quality is equal to about 25% of their sales. Keep in mind this is only an average—some spend as much as 40-50%. These big spenders are the ones who can benefit most from tracking their cost of quality.

IT departments are increasingly responsible for not only the quality of internal IT services and projects, but also for customer-facing deliverables. Digital transformations are sweeping across businesses in all industries, heightening the need for IT leaders to understand, analyze, and track this key metric.

What Is Cost of Quality?

Cost of quality (COQ) is made up of expenses incurred to meet a target quality level for a product or service, plus any costs incurred when that level of quality is not met and corrective actions need to be made. In other words, COQ identifies an organization’s costs related to quality conformance and non-conformance.

According to iSixSigma, COQ can be broken down as follows:

Cost of Quality Components

Conformance

Appraisal Costs: Any cost related to inspecting products to ensure there are no defects. Defect tracking software, product inspections, and test environment setup all contribute to ensuring there are no defects.

Prevention Costs: Any cost related to reducing or removing the presence of quality issues from the outset. Risk analysis, quality assurance, and corrective action work to prevent future defects from occurring are considered prevention costs.

Non-Conformance

Internal Failure Costs: Cost incurred when a defect is found during production. Scrap, rework, and non-productive time waiting for defect correction are examples of internal failure costs.

External Failure Costs: Cost incurred when post-production defects are found. Liability costs, lost customer sales, and complaint investigation are examples of external failure costs.

Quality costs are often compared to icebergs. There are obvious costs like rework and retesting that lay above the surface. These costs are often small compared to what is below the surface. Unproductive time due to defects, customer complaint investigations, and other unforeseen quality activities are the significant drivers of the total COQ.

What Does Optimal Quality Look Like?

Quality is never perfect. (If it were, there would be no need for such an assessment and companies would spend nowhere near a quarter of their sales on it.) So, what is the definition of success when it comes to quality?

The answer is different for every organization but it looks something like this:

Source: Jurans Quality Control Handbook, via qualityamerica.com

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Based on the processes in place within your organization, there is a theoretical “sweet spot” where the total cost of quality is at its lowest.

In practice, the sweet spot is typically closer to “Exceptional Quality” on the X axis because failure costs become very expensive as they accumulate. For instance, if a product is found to have numerous defects, then there is extensive action that needs to be taken to rectify it: triaging, researching, planning around the defects, reworking processes, and retesting. If external failures are found, the costs become even more extensive: recalls, warranties, potential lawsuits, and worst of all, loss of sales and customer goodwill. Lost sales and goodwill are very hard to quantify but are extremely important factors to consider. Ultimately, it’s your reputation on the line when quality falters.

Over-investing in prevention and appraisal may drive down failure costs, but will eventually result in an increase in total cost as well. Finding your organization’s definition of success starts with understanding your quality spend. From there you can assess the appropriate amount to spend on preventing and measuring failure.

How to Assess Cost of Quality

If your organization has never conducted a cost of quality assessment, it can be helpful to bring in a third party to do so. A third-party resource is independent of the political and other internal cultural factors that can skew such an assessment. They are also likely to ask more questions and make fewer assumptions, because they are not performing the business processes directly. Independence ultimately results in more accurate, candid data.

Follow these steps to perform a cost of quality assessment:

Document the process as you go. Documentation expedites future assessments by revealing how and where the source information was found.

Create a COQ Matrix. This tool will be used to document the people you talk to, method for obtaining info, associated cost, etc.

Gather information through interviews, documents, defect tracking, etc. This information is the basis for cost estimations.

Analyze findings. Identify areas in which there are outliers: either too much or too little spending on quality.

Provide recommendations for improvement. Use visual aids backed by data to identify opportunities for cost savings, quality tracking, and quality improvement recommendations

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Cost of Quality Reporting

Oftentimes, quality elements will be tracked in unnecessarily complicated spreadsheets. To improve COQ reporting, visuals are always better. Pie charts and Pareto diagrams are great ways for management to easily digest and interpret information on a high level.

Below is a comparison of a COQ assessment from a company with poor quality versus a company with good quality. The company with poor quality incurs higher failure costs compared to prevention and appraisal, whereas the company with good quality maintains four well-distributed quadrants:

Well-distributed spending across the four COQ areas is indicative of well-managed quality. Spending the money to drive down failure costs will ultimately result in a better reputation. Whereas high failure costs can result in intangibles like loss of loyalty and goodwill. The “Good Quality” organization will likely have lower total quality spending while maintaining a higher value of their products and services.

Calculating Cost of Quality Is a Worthwhile Challenge

Many organizations, especially those who do not perform COQ assessments, are focused on detection over prevention, or Quality Control over Quality Assurance. It’s typical for an organization like this to have few quality tracking processes in place. Performing a cost of quality assessment is a lot like private detective work. You will find many elements of quality that are simply not tracked, making it nearly impossible to assign a cost. You will need to make gross estimates and you will encounter a lot of uncertainty and apprehension.

The uncertainty is okay! Down the road, it will be valuable to have a documented system in place for monitoring quality spending. With proper documentation and good recommendations for how to move forward, a follow-up assessment will be much easier.

Cost of quality can and should be tracked regularly to better understand how process changes affect it. Consistently monitoring quality is a part of being focused on Quality Assurance, and on delivering exceptional quality.

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