© Max Zornada (2005)Slide 1 The Cost of Quality and the Cost of Poor Quality "Defects and errors are not free. Someone makes them and gets paid for making them. Even more people are paid to repair and recover from the consequences."

© Max Zornada (2005)Slide 2 The way things should be …. Cost = $A Per Unit Something we do for a customer Product/Service/Transaction etc. Cost $A/Unit Revenue = $B per Unit Profit = $(B-A)

© Max Zornada (2005)Slide 3 But sometimes things go wrong ….! Cost = $A Per Unit Revenue = $B per Unit Profit = $(B-2A) Cost = $A Per Unit Something goes wrong! Cost = $A Per Unit Rework the old one Scrap the old one and do again. Simplifying assumption for this example: Cost of rework = cost of doing again. Cost = $2A per Unit delivered % error or defect rate This is the Cost of Poor Quality

© Max Zornada (2005)Slide 4 Not just the cost but the lost opportunity … (not always easy to quantify) Cost = $A Per Unit Revenue = $2B Profit = $2(B-A) Cost = $A Per Unit Costs = $2A Cost = $A Per Unit A good or service we could have made with the resources we used to recover from the mistake, if we had got it right first time.

© Max Zornada (2005)Slide 5 Impact of the Cost of Quality Example Often called the Cost of Poor Quality (COPQ) Processing Cost to Deliver 1 Good Outcome Revenue per Good Outcome Delivered Profit Margin B = $100 A = $70B - A = $30 B = $100 2A = $140B - 2A = - $40 2B = $200 2A = $1402(B - A) = $60 The Opportunity Cost to the Business = $40 + $60 = $100 I.e. They could have earned $60 with the time and resources that went into losing $40. The basic cost structure When a “defect” occurs The value of the missed opportunity

© Max Zornada (2005)Slide 6 Financial Services Group Conventional View of Costs vs COQ View of Costs

© Max Zornada (2005)Slide 7 l Administration l Finance and Accounting l IT l Legal Services l Human Resource Management Financial Services Group - Southern Region Business Unit Organisation Structure Other Shared Services Depts. Transaction Processing Team Customer Communications Team GM Operations Customer Support (Call Centre) GM Customer Support Policy and Procedures Group Training and Development Group GM Shared Services Chief Operating Officer Southern Region Other Shared Services Departments Outside the scope of this analysis Problem Investigation Team Document Receiving Team

© Max Zornada (2005)Slide 8 Document Receiving Team Transaction Processing Team Customer Communications Team Problem Investigation Team Customer Support (Call Centre) Operations Customer Support Schematic Diagram of the FSG Work Flow 600 transactions/day

© Max Zornada (2005)Slide 9 Financial Services Group Some simplifying assumptions l The “all-up” cost/FTE - including Salary, Employee on-costs, allocation of relevant overheads is $50,000/FTE. l The average number of transactions processed daily (output) is 600. l Questions: l Use the attached template to develop the overall cost structure for the business; l What is the processing cost expressed as a cost per transaction? (assume 250 working days/year).

© Max Zornada (2005)Slide 10 Financial Services Group - Southern Region Business Unit Cost Structure FTE’s Cost by Workgroup Cost by Division Total Cost Other Shared Services Depts. Transaction Processing Team Customer Communications Team GM Operations Customer Support (Call Centre) GM Customer Support Policy and Procedures Group Training and Development Group GM Shared Services Chief Operating Officer Southern Region Problem Investigation Team Document Receiving Team (FTE = Full Time Equivalent)

© Max Zornada (2005)Slide 11 Cost of Quality Categories l Prevention l Those activities and costs associated with allowing things to be done correctly. "Doing it right the first time". l Appraisal l Those activities and costs associated with checking to ensure things have been done correctly. l Failure l Those activities and costs caused by things not being done right the first time. ie. correcting problems once they have occurred.

© Max Zornada (2005)Slide 12 Failure Costs (usually referred to as COPQ) l Internal Failure l Failures which happen and are corrected internally within the organisation, which add to costs but which the customer does not see. eg. scrap, rework. l External Failure l Failures which happen during and after delivery of the product or service to the customer, which impact on the customer and hence the customer's perception of the product, service and organisation.

© Max Zornada (2005)Slide 13 COQ - Some Examples Prevention l Training l Procedure Development l Policy Development l Standards and Specifications l Planning l Six Sigma/ Improvement Teams l Preventive Maintenance l Quality Assurance Activities l Recruitment l Templates and Tools Appraisal l Inspection l Audits and checks l Process control l Quality Control Activities l Testing l Performance measuring l Customer surveys l % of Supervision l % of Management l Part of the cost of the IT and Reporting infrastructure.

© Max Zornada (2005)Slide 14 COQ Examples - Failure Internal Failure l Cost of Correction and Rework l Cost of Rejects and Scrap l Downtime l Reinspection l Inventory buffers/excess inventory l System and procedure failures l Isolating causes and corrective action External Failure l Customer complaints l Warranty costs l Customer compensation costs l Product liability l Lost market share l Delivery delays l Unplanned field services l Invoice errors/adjustment

© Max Zornada (2005)Slide 15 COQ - How Significant is it ? l Industry Surveys suggest that: l approximately 25% of labour and assets in a manufacturing firm; l range between 20% and 30% of revenue; l e.g. banking example COQ = 60% Prevention Appraisal Failure 45.0% 33.0% 22.0%

© Max Zornada (2005)Slide 16 COQ - How Significant is it ? l Industry Surveys suggest that: l approximately 25% of labour and assets in a manufacturing firm; l range between 20% and 30% of revenue; l In service businesses COQ is significantly higher. l Examples from the presenter’s consulting case file: Type of Business Bank Funds/ Wealth Management Financial Service Transaction Processing COQ as % of Total Cost 60% Prev’n as % of COQ Appraisal as % of COQ Failure as % of COQ 56% 49% 45% 16% 26% 33% 19% 39% 22% 35%

© Max Zornada (2005)Slide 17 The Cost of Quality view of cost structure? Failure Appraisal Prevention Cost of Quality Components Cost of Performing Core Tasks (not to scale)

© Max Zornada (2005)Slide 18 Cost of Quality Objectives l Reduce time spent on Failure and eventually Appraisal by increasing time spent on Prevention; l Reduce total COQ overall, to enable more resources to be spent on core activities, satisfying customers, internal and external; l Add prevention activities that lead to reductions in Failure and Appraisal Cost that are greater than the cost of the prevention activity that was added.

© Max Zornada (2005)Slide 19 Changes in the Cost Structure Prevention Appraisal Failure Total Costs of Doing Business Before Total Costs of Doing Business After Failure Appraisal Prevention

© Max Zornada (2005)Slide 20 Document Receiving Team Transaction Processing Team Customer Communications Team Problem Investigation Team Customer Support (Call Centre) Operations Customer Support FSG Revisited 600 2% internal errors 8% rework 2% of total work for Transaction Processing Team Policy and Procedures Group Training and Development Group Shared Services 100% Prevention 48% Appraisal 40% Core Task 12% Failure 100% Core Task 100% Failure 20% Failure 80% Core Task 12% Failure 88% Core Task

© Max Zornada (2005)Slide 21 A COQ Based View of FSG’s Cost Structure Document Receiving Team Transaction Processing Team Customer Comms Team Customer Support (Call Centre) Problem Investigation Team Training and Dev./ Policy & Procedures OperationsCustomer SupportS/Serv. Total by Process Total COQ FAPCFAPC 4,000,000 1,000,000 7,500,000 2,000,000400, ,000 15,400,000

© Max Zornada (2005)Slide 22 FSG Cost Structure A potential improvement scenario Prevention Appraisal Failure Appraisal Prevention 10,800, ,000 1,920,000 2,180,000 15,400,000 Core 12 Month Improvement Strategy Increase Prevention by 100% to reduce Failure by 50% 14.2% 12.5% 3.3% 70% Core 10,800,000 $102.67/transaction 1,000,000 1,920,000 1,090,000 14,810,000 $98.73/transaction 7.2% 13% 6.8% 73% Before After

© Max Zornada (2005)Slide 23 Using Cost of Quality l The COQ measures the performance of an organisation in terms of the efficiency and effectiveness of its business and work processes, systems and practices. l Using COQ l To identify and prioritise opportunities/problem areas; l To assess COQ profiles: l As an objective performance measure for progress in overall quality improvement - the “Ultimate” measure of improvement; l If COQ didn’t reduce whatever you did, didn’t work! l To determine which is the most appropriate improvement strategy to be used – problem solving (PS) or process change (BPR). l If Failure=High use PS if Failure=Low use BPR.

© Max Zornada (2005)Slide 24 COQ: A more useful way of looking at cost and cost structure Cost of Core Task See cost as being Like this Not like this Cost Failure Appraisal Prevention

© Max Zornada (2005)Slide 25 Cutting costs while improving service outcomes? Reduce costs and cost structure by cutting Like this Not like this Cost of Core Task Cost Failure Appraisal Prevention

© Max Zornada (2005)Slide 26 Consider what happens when we cut costs like this... Cost Cost of Core Task Failure Appraisal Prevention We have cut our capability to perform the core task We have cut the “insurance” elements we build into our processes to ensure we get it right first time and to detect when we didn’t get it right first time. What would you expect will happen? In the Short Term? In the Medium to Long Term?

© Max Zornada (2005)Slide 27 End of COQ Module