Total Quality Management

1. Total Quality Management Week # 7 Cost of Quality Prepared by: Khalid Dahleez Faculty of Commerce – the Islamic University of Gaza This material was collected from different sources Total Quality Management - Spring 2010 - IUG

2. Understand Quality Costs • Understand quality costs enables you to • Understand hidden costs • Reduce and eliminate unnecessary cost • Prevent problems from happening • Management responsibility to enable this • Quality costs are real and estimated at: • 25% of costs in manufacturing • 35% of costs in service industry • Quality costs can be categorised to enable better understanding Total Quality Management - Spring 2010 - IUG

3. Why calculate Quality Cost • Management will give special attention when quality is measured in monetary terms • Quality costing is one of the tools • to provide initial assessments and hard evidence that improvement is needed or had been made • To monitor the effectiveness of quality improvement initiatives • To be used in a generic term by senior management, shareholders and financial institutions, so that they can readily understand implication of quality in the term of money • Cost of quality failure is calculated as a percentage of profit or annual turnover • It is easy to understand • By front-line operator • By middle management Total Quality Management - Spring 2010 - IUG

4. Benefits of using quality costing • Greater accuracy in the evaluation and forecasting of resource use • Justification for investment in the prevention and appraisal of failures • Ability to cost and compare performance across all departments functions and activities • Identification and prioritization of activities, processes and departments in terms of corrective action, investment, or quality improvement initiatives Total Quality Management - Spring 2010 - IUG

5. Benefits of using quality costing (2) • Ability to set cost-reduction targets and then to measure and report progress • Ability to produce “local” data which improves understanding of resource utilization objectives and targets at all levels throughout the company • Provision of data to support formal quality management system (including, especially; those based upon the ISO9000) • Enable decisions about quality to be made in an objective and systematic manner • Promoting TQM and a company-wide quality improvement culture Total Quality Management - Spring 2010 - IUG

6. COST OF QUALITY • Quality costs are defined as costs associated with non-achievement of product/service quality. In simple terms, quality cost is the cost of poor products/services. • The cost of poor quality can add to other costs such as design, production, maintenance, inspection, sales, etc. Quality costs cross department boundaries by involving all activities of the organization – marketing, purchasing, design, manufacturing, service, etc. • The price of nonconformance (Philip Crosby) or the cost of poor quality (Joseph Juran), the term 'Cost of Quality', refers to the costs associated with providing poor quality product or service. Total Quality Management - Spring 2010 - IUG

7. Founders Point of View • Phillip B. Crosby (Quality is free . . . ): • The system for causing quality is prevention, not appraisal – Quality is Free • The performance standard must be Zero Defects, not "that's close enough" • The measurement of quality is the Price of Non-conformance. • Cost of quality is only the measure of operational performance • “Quality is free. It’s not a gift, but it is free. What costs money are the unquality things -- all the actions that involve not doing jobs right the first time.” Total Quality Management - Spring 2010 - IUG

8. Total Quality Management (TQM) Customers will seek out the highest quality product. Improved quality that exceeds customer expectations will generate more revenues that exceed the cost of quality. Therefore, quality is “free”. Total Quality Management - Spring 2010 - IUG

9. Total Quality Management (TQM) W. Edwards Deming proposed that improving quality reduces cost and improves profitability. Quality can be and should be improved continuously. Revenues Max Profit Cost Max Quality Total Quality Management - Spring 2010 - IUG

10. Max Profit Return on Quality (ROQ) The optimum quality level is always achieved before maximum attainable profit is reached. Profit is maximized at the optimum quality level. Cost Revenues Optimum Quality Total Quality Management - Spring 2010 - IUG

11. Founders Point of View • Feigenbaum (Originator of ‘Total Quality’ concept) • Definition of Quality costs (1956) • Appraisal costs • Prevention costs • Failure costs Total Quality Management - Spring 2010 - IUG

12. Cost of Quality • Cost of Achieving Good Quality • Prevention costs • costs incurred during product design • Appraisal costs • costs of measuring, testing, and analyzing • Cost of Poor Quality • Internal failure costs • include scrap, rework, process failure, downtime, and price reductions • External failure costs • include complaints, returns, warranty claims, liability, and lost sales Total Quality Management - Spring 2010 - IUG

13. Prevention Costs • Quality planning costs • costs of developing and implementing quality management program • Product-design costs • costs of designing products with quality characteristics • Process costs • costs expended to make sure productive process conforms to quality specifications • Training costs • costs of developing and putting on quality training programs for employees and management • Information costs • costs of acquiring and maintaining data related to quality, and development of reports on quality performance Total Quality Management - Spring 2010 - IUG

14. Examples of prevention Cost • Application screening • Capability studies • Controlled storage • Design review • Equipment maintenance & repair • Field testing • Fixture design and fabrication • Forecasting • Housekeeping • Job descriptions • Market analysis • Pilot projects • Procedure writing • Prototype testing • Procedure reviews • Quality incentives • Safety reviews • Time and motion studies • Survey • Quality training • salesperson evaluation and selection • Personnel reviews Total Quality Management - Spring 2010 - IUG

15. Appraisal Costs • Inspection and testing • costs of testing and inspecting materials, parts, and product at various stages and at the end of a process • Test equipment costs • costs of maintaining equipment used in testing quality characteristics of products • Operator costs • costs of time spent by operators to gather data for testing product quality, to make equipment adjustments to maintain quality, and to stop work to assess quality Total Quality Management - Spring 2010 - IUG

16. Examples of appraisal cost • Audit • Document checking • Diagram checking • Equipment calibration • Final inspection • In-process inspection • Laboratory test • Personnel testing • Procedure testing • Prototype inspection • Receiving inspection • Shipping inspection Total Quality Management - Spring 2010 - IUG

17. Internal Failure Costs • Scrap costs • costs of poor-quality products that must be discarded, including labor, material, and indirect costs • Rework costs • costs of fixing defective products to conform to quality specifications • Process failure costs • costs of determining why production process is producing poor-quality products • Process downtime costs • costs of shutting down productive process to fix problem • Price-downgrading costs • costs of discounting poor-quality products—that is, selling products as “seconds” Total Quality Management - Spring 2010 - IUG

18. External Failure Costs • Customer complaint costs • costs of investigating and satisfactorily responding to a customer complaint resulting from a poor-quality product • Product return costs • costs of handling and replacing poor-quality products returned by customer • Warranty claims costs • costs of complying with product warranties • Product liability costs • litigation costs resulting from product liability and customer injury • Lost sales costs • costs incurred because customers are dissatisfied with poor quality products and do not make additional purchases Total Quality Management - Spring 2010 - IUG

19. Defects, Scrap, Rework, Inspection, Returns, Warranty, Quality Assurance Prevention Design Review, Zero Defects Program, Supplier Training, Supplier Evaluation, Specification Review, Quality Audits, Preventive Maintenance, Engineering Changes, Product Liability, Increased Overhead Appraisal Vendor Surveillance, Receiving Inspection, Product Acceptance, Process Control, Inspection Labor, Quality Control Labor, Testing Equipment Costs Internal Failure Downtime, Engineering Changes, Excess Inventory, Disposal Costs, Reinsertion External Failure Consumer Affairs, Purchase Changes, Service after Sales, Product Liability, Lost Market Share Delivery Delay Total Quality Management - Spring 2010 - IUG

20. Classifying Quality Costs Total Quality Management - Spring 2010 - IUG

21. Total Quality Management - Spring 2010 - IUG

22. Prevention Costs Appraisal Costs Benefit $ Repair Costs Prevention Costs • Failure Costs • Internal • External Appraisal Costs Repair Costs Failure Costs Before Quality Cost Alignment After Quality Cost Alignment Preventing Poor Quality (Comparison) Total Quality Management - Spring 2010 - IUG

23. Cost of Quality (other version) 1. Like all things there is a price to pay for quality. This total cost can be split into two fundamental areas: • a. Non Conformance. This area covers the price paid by not having quality systems or a quality product. Examples of this are: (1) Rework. Doing the job over again because it wasn't right the first time. (2) Scrap. Throwing away the results of your work because it is not up to the required standard. (3) Waiting. Time wasted whilst waiting for other people. (4) Down Time. Not being able to do your job because a machine is broken. • b. Conformance. Conformance is an aim of quality assurance. This aim is achieved at a price. Examples of this are: (1) Documentation. Writing work instructions, technical instructions and producing paperwork. (2) Training. On the job training, quality training, etc. (3) Auditing. Internal, external and extrinsic. (4) Planning. Prevention, do the right thing first time and poka yoke. (5) Inspection. Vehicles, equipment, buildings and people. Total Quality Management - Spring 2010 - IUG

24. Cost of Quality (other version) 2. These two main areas can be split further as shown below: FIGURE 1.3 Total Quality Management - Spring 2010 - IUG

25. 1-10-100 Rule 1 Prevention 10 $ $ Correction $ $ 100 $ Failure $ $ $ $ $ Total Quality Management - Spring 2010 - IUG

26. The 1:10:100 rule: • Re.1 spent on prevention will save Rs.10 spent on appraisal and Rs.100 on failure costs. • One dollar spent on prevention will save $10 on appraisal and $100 on failure costs. • This rule helps one to prioritize expenditure on prevention, which is sure to bring in greater returns. • “The earlier you detect and prevent a defect the more you can save. If you catch a two cent resistor before you use it and throw it away, you lose two Cents. If you don’t find it until it has been soldered into a computer component, it may cost $10 to repair the part. If you don’t catch the component until it is in the computer user’s hands, the repair will cost hundreds of dollars. Indeed, if a $5000 computer has to be repaired in the field, the expense may exceed the manufacturing cost.” Total Quality Management - Spring 2010 - IUG

27. Difficulties in using Quality costing • Management have not believed in the possibilities of improvement • Quality costing is demanding • It requires a lot of data of each activity related to quality • Other limitations • Does not resolve quality problems • Does not provide specific actions • vulnerable to short-term mismanagement • difficult to match effort and accomplishment • subject to measurement errors • may neglect important or include inappropriate costs Total Quality Management - Spring 2010 - IUG

28. Steps in implementing quality cost • Involve accountants right from the start • Decide purpose and objectives • Decide how to deal with overheads • Distinguish between basic work and quality related activities • Collection data which offers the prospect of real gains • Start by examining failure costs • Evaluate the costs of inspection • Analyze and use the data • Collecting and reporting quality cost data Total Quality Management - Spring 2010 - IUG

29. Preventing Poor Quality • Would it not make sense to prevent poor quality products from happening? • How can this be done? • Whose responsibility is this? Total Quality Management - Spring 2010 - IUG

30. How to Prevent Poor Quality • Prepare to measure costs of quality • Determine categories of quality costs • Create measurement system that captures categories of quality costs • Assign responsibility to collect data • Analyse collected data Total Quality Management - Spring 2010 - IUG

31. Determine Quality Cost Categories • Understand your product • Understand your process • Understand where problems occur • Determine precisely what goes wrong • Determine what costs represents each problem Total Quality Management - Spring 2010 - IUG

32. Creating Data Collection System • Create measurement system • Attempt to harness existing financial accounting system • Manipulate existing financial data • Collect costs as they occur • Whatever you do ensure costs are accurate Total Quality Management - Spring 2010 - IUG

33. Assign Responsibility • Make individuals at all levels responsible for collecting quality cost data: • If quality cost data is required then make it the responsibility of the person who creates the cost to collect the data • If no one is responsible no one will bother Total Quality Management - Spring 2010 - IUG

34. Analyse Collected Data • Data on its own is useless • You must have it analysed to be able to extract meaning • Determine what knowledge you require • Develop an analysis system that provides the knowledge you require Total Quality Management - Spring 2010 - IUG

35. Useful Quality Cost Knowledge • What you need to know is useful • What you do not need to know is useless • Only ask for knowledge you need to know • Demand that knowledge is presented so that it can be understood easily Total Quality Management - Spring 2010 - IUG

36. Management is Responsible • Management decides what to produce in terms of Products (goods and / or services) • Management assigns responsibilities to produce products • Management is accountable for effectively using resources to produce products Total Quality Management - Spring 2010 - IUG

37. History of Activity-Based Costing • Term “activity-based costing” created in 1975 by Dr. Robert Kaplan • Resulted from dissatisfaction with traditional accounting categories • Identifies activities as the fundamental cost object of an organization • Widely used in industries (e.g. FedEx, Texas Instruments…) Total Quality Management - Spring 2010 - IUG

38. Benefits Associated With ABC • More precise cost information • Improved cost control and management • Improved insight into cost causation • Better performance measures Total Quality Management - Spring 2010 - IUG

39. Definitions • Activity Based Costing (ABC) is a methodology that measures the cost and performance of resources, activities and cost objects. Cost objects consume activities, and activities consume resources. • Activity Based Management (ABM) is the broad discipline that focuses on achieving customer value through the continuous management of activities. ABM draws on ABC cost information and performance measurement as a major (but not only) source of information. Total Quality Management - Spring 2010 - IUG

40. The Link Between Quality and Productivity • Effective quality improvement can be instrumental in increasing productivity and reducing cost. • The cost of achieving quality improvements and increased productivity is often small. Total Quality Management - Spring 2010 - IUG

41. Summary Slide • The following Slides are for understanding only (subject to indirect Questions): “ 37, 38, 39, 40” • Other slides are required and subjects to any type of Questions Total Quality Management - Spring 2010