As companies look for ways to earn better profits, managers tend to put programs in place that will cut costs and increase revenues. This, however, is not necessarily the road to achieving higher profits. Understanding your Cost of Quality (COQ) is one significant factor in determining your business’ financial success.
The Cost of Quality is a term that is widely used, but often misunderstood. The COQ is not the price of creating a quality product or service, but rather the cost of NOT creating a quality product or service. Hence, every time work is redone, your COQ increases. For example, every time you have to re-visit a service call or correct a financial statement, you are increasing your COQ, and thus, impacting your operational efficiency and profitability.
The American Society for Quality Control (ASQC), the leading authority in the United States on defining the education process in quality and for facilitating new ideas, has defined the generally accepted definitions for the Cost of Quality (COQ) elements. The total quality costs are comprised of the following components:
l The investment in the prevention of non-conformance to requirements
l The cost of appraising a product or service for conformance to requirements
l The cost of failing – both internally and externally – to meet requirements
These elements will be specific for each type of business; however, they will have some commonality. Let’s take a closer look at some examples:
Prevention Costs: the cost of all activities specifically designed to prevent poor quality in products or services
l New Product Review
l Quality Planning
l Employee Training
l Set-up Procedures
l Quality Improvement Team Meetings
Appraisal Costs: the costs associated with measuring, evaluating or auditing products or services to assure conformance to quality standards and performance requirements
l Inspection and Testing of Incoming Products
l Product, Process and Service Audits
l Calibration of Measuring and Testing Equipment
Failure Costs: the costs resulting from products or services not conforming to requirements or customer needs. Failure costs are further divided into internal and external failure categories.
Internal Failure Costs: Failure costs occurring prior to the delivery or shipment of the product or the furnishing of a service to the customer
l Rework
l Re-inspection
l Re-testing
External Failure Costs: Failure costs occurring after the delivery or shipment of the product or during or after the furnishing of a service to the customer
l Processing Customer Complaints
l Customer Returns
The total quality costs are the sum of the above costs. In other words, the difference between the actual cost of a product or service and what the reduced cost would be if there were no possibility of substandard service, failure of products or defects in manufacture is your total COQ.
The goal of tracking your cost of quality is to define operating cost reduction opportunities and to provide the impetus for action on those costs. The strategy is to take direct action on failure costs and attempt to drive them to zero dollars. The action needed is to invest in the right prevention costs through planning to gain profound knowledge of the causes of internal and external failures, and to evaluate and redirect prevention efforts to gain further improvement. This strategy is based on the premise that for each failure there is a root cause and that causes are preventable and prevention is less costly.
According to the ASQC, the typical cost of quality is 25% to 30% of revenue. The majority of these costs are in non-conformance elements of external and internal failures. So to get started on a COQ analysis, a company needs to define its elements of external and internal failures, consider cost of prevention and then project two comparative financial models. One model would show the situation as it currently exists and one that portrays the optimum financial potential when all systems are at peak performance.
While putting a COQ system in place is not a simple task, the rewards can be substantial. For example, “Xerox reported a savings of $53 million in the first year of its COQ program followed by savings of $77 million, $60 million, and $20 million in the next three years. (Carr, 1995). Xerox credits several key factors as being responsible for the program’s success: (1) using COQ as a tool to help line managers better serve their customers rather than as a financial or accounting measure; (2) Clearly communicating that the COQ measures would not be used to judge individual performance or to eliminate jobs; (3) Measures were based on rough numbers, not exact calculations (Carr, 1992).”
While your dealership is probably not as large as Xerox, you still can benefit from putting a COQ system in place. To implement a successful COQ program in your company takes teamwork and a commitment from management. Oftentimes companies bring in change agents to assist in developing a COQ system. Once you have identified your cost of quality and uncovered areas where you may be failing, management can make more informed decisions when implementing change processes designed to improve quality and thereby, improve operational efficiency and profitability.
