1. Quality Costs and Productivity: Measurement, Reporting, and Control
CHAPTER
Quality Costs and Productivity: Measurement, Reporting, and Control

2. After studying this chapter, you should be able to:
Objectives
1. Identify and describe the four types of quality costs.
2. Prepare a quality cost report and explain the difference between the conventional view of acceptable quality level and the view espoused by total quality control.
3. Tell why quality cost information is needed and how it is used.
4. Explain what productivity is, and calculate the impact of productive changes on profits.
After studying this chapter, you should be able to:

3. Quality Defined
A quality product or service is one that meets or exceeds customer expectations...

4. Quality Defined … on the following eight dimensions: Performance
Aesthetics
Serviceability
Features
Reliability
Durability
Quality of conformance
Fitness for use

5. Quality Defined … on the following eight dimensions: Performance
How consistently and well a product functions
Performance
Aesthetics
Serviceability
Features
Reliability
Durability
Quality of conformance
Fitness for use
The appearance of tangible products (style, beauty)
Measures the ease of maintaining and/or repairing the product
Characteristics of a product that differentiate functionally similar products
The probability that the product or service will perform its intended function for a specified length of time

6. Quality Defined … on the following eight dimensions: Performance
The length of time a product functions
Performance
Aesthetics
Serviceability
Features
Reliability
Durability
Quality of conformance
Fitness for use
A measure of how a product meets its specifications
The suitability of the product for carrying out its advertised functions

7. A defective product is one that does not conform to specifications.
Quality Defined
A defective product is one that does not conform to specifications.

8. Zero defects means that all products conform to specifications.
Quality Defined
Zero defects means that all products conform to specifications.

9. Quality Defined
The definition of quality-related activities imply four categories of quality costs:
Incurred to prevent poor quality or services being produced
Incurred to determine whether products and services conform to requirements
Preventive costs
Appraisal costs
Internal failure costs
External failure costs
Incurred when products and services do not conform to specifications
Incurred when products and services fail to conform to requirements after being delivered

10. Examples of Quality Costs
Prevention costs
Quality engineering
Quality training programs
Quality planning
Quality reporting
Supplier evaluation and selection
Quality audits
Quality circles
Field trials
Design reviews

11. Examples of Quality Costs
Appraisal Costs
Inspection of raw materials
Testing of raw materials
Packaging inspection
Supervising appraisal
Product acceptance
Process acceptance
Inspection of equipment
Testing equipment
Outside endorsements

12. Examples of Quality Costs Internal failure costs
Scrap
Rework
Downtime (defect related)
Reinspection
Retesting
Design changes

13. Examples of Quality Costs External failure costs
Cost of recalls
Lost sales
Returns/allowances
Warranties
Repairs
Product liability
Customer dissatisfaction
Lost market share
Complaint adjustment

14. Measuring Quality Costs
Hidden Quality Costs are opportunity costs resulting from poor quality.
The Multiplier Method
The Market Research Method
Taguchi Quality Loss Function

15. The Multiplier Method
The multiplier method assumes that the total failure cost is simply some multiple of measured failure costs:
Total external failure cost = k(Measured external failure costs)
where k is the multiplier effect
If k = 4, and the measured external failure costs are $2 million, then the actual external failure costs are estimated to be $8 million.

16. The Market Research Method
The market research method uses formal market research methods to assess the effect of poor quality on sales and market share.
Customer surveys and interviews with members of a company’s sales force can provide significant insight into the magnitude of a company’s hidden costs.
Market research results can be used to project future profit losses attributable to poor quality.

17. The Taguchi Quality Loss Function
The Taguchi loss function assumes any variation from the target value of a quality characteristic causes hidden quality costs.
Furthermore, the hidden quality costs increase quadratically as the actual value deviates from the target value.

18. The Taguchi Quality Loss Function
$ Cost
Lower Specification Limit
Upper Specification Limit
Target Value

19. The Taguchi Quality Loss Function
L(y) = k(y – T)²
k = A proportionately constant dependent upon the organization’s external failure cost structure
y = Actual value of quality characteristic
T = Target value of quality characteristic
L = Quality loss

20. Quality Cost Report Unit Actual Diameter (y) y-T (y –T)² k(y-T)²
$ 4.00
Total $40.00
Average $10.00

21. For the Year Ended March 31, 2004
Image Products
Quality Cost Report
For the Year Ended March 31, 2004
11-22
Quality Costs % of Sales
Prevention costs:
Quality training $35,000
Reliability engineering 80,000 $115, %
Appraisal costs:
Materials inspection $20,000
Product acceptance 10,000
Process acceptance 38,000 68,
Internal failure costs:
Scrap $50,000
Rework 35,000 85,
External failure costs:
Customer complaints $25,000
Warranty 25,000
Repair 15, ,
Total quality costs $333, %

22. Relative Distribution of Quality Costs
External Failure (19.5%)
Prevention (34.5%)
Internal Failure (25.6%)
Appraisal (20.4%)

23. Quality Cost Graph Total Quality Costs Cost Failure Costs
AOL
Control Costs
100%
Percent Defects

24. Contemporary Quality Cost Graph
Total Quality Costs
Failure Costs
Control Costs
100%
Percent Defects

25. Trend Analysis Assume the following data:
Quality Costs Actual Sales % of Sales
$440, $2,200, %
, ,350,
, ,750,
, ,800,
, ,800,

26. Multiple-Period Trend Graph: Total Quality Costs
% of
Sales 20 15 10 5
Year

27. Multiple-Trend Analysis for Individual Quality Costs
Assume the following quality cost data:
Internal External
Prevention Appraisal Failure Failure
%1 2.0% 6.0% 10.0 %
,5 4.5
1Expressed as a % of sales

28. Multiple-Period Trend Graphic: Individual Quality Cost Categories
Percentage of Sales 10 9 8 7 6 5 4 3 2 1
Prevention
Appraisal
Internal failure
External failure
Year

29. Productivity: Measurement and Control
Productivity is concerned with producing output efficiently, and is it specifically addresses the relationship of output and the inputs used to produce the outputs.

30. Productivity: Measurement and Control
Total productive efficiency is the point at which two conditions are satisfied:
1. for any mix of inputs that will produce a given output, no more of any one input is used than necessary to produce the output
2. given the mixes that satisfy the first condition, the least costly mix is chosen.

31. Technical Efficiency
Technical Efficiency is the condition where no more of any one input is used than necessary to produce a given output.
Technical efficiency improvement is when less inputs are used to produce the same output or more output are produced using the same input.
Current productivity
Inputs:
Labor
Capital 4
Outputs: 6

32. 3 6 4 8 Technical Efficiency Same Output, Fewer Inputs Inputs:
Labor
Capital 3
Outputs: 6
More Output, Same Inputs
Inputs:
Labor
Capital 4
Outputs: 8

33. 3 8 3 8 Technical Efficiency More Output, Fewer Inputs Inputs:
Labor
Capital 3
Outputs: 8
Technically Efficient Combination I:
Inputs:
Labor
Capital
$20,000,000 3
Outputs: 8

34. 2 8 Technical Efficiency Technically Efficient Combination II: Inputs:
Labor
Capital
$25,000,000 2
Outputs: 8
Of the two combinations that produce the same output, the least costly combination would be chosen.

35. Partial Productivity Measurement
Partial Productivity Measurement: Measuring productivity for one input at a time.
Partial Measure = Output/Input
Operational Productivity Measure: Partial measure where both input and output are expressed in physical terms.
Financial Productivity Measure: Partial measure where both input and output are expressed in dollars.

36. Profile measurement provides a series or a vector of separate and distinct partial operational measures.

37. Profile Productivity Measures
Example 1:
The productivity of both labor labor and materials moves in the same direction:
Number of motors produced 120, ,000
Labor hours used 40,000 37,500
Materials used (lbs.) 1,200,000 1,428,571
150,000/37,500
150,000/1,428,571
Partial Productivity Ratios
2003 Profile Profile
Labor productivity ratio
Material productivity ratio

38. Profile Productivity Measures
Example 2:
Assume the same data as Example 1 except the material used is 1,700,000 pounds.
Number of motors produced 120, ,000
Labor hours used 40,000 37,500
Materials used (lbs.) 1,200,000 1,700,000
150,000/37,500
150,000/1,700,000
Partial Productivity Ratios
2003 Profile Profile
Labor productivity ratio
Material productivity ratio

39. Profit-Linked Productivity Measurement
Profit-Linkage Rule: For the current period, calculate the cost of the inputs that would have been used in the absence of any productivity change, and compare this cost with the cost of the inputs actually used. The difference in costs is the amount by which profits changed because of productivity changes.
To compute the inputs that would have been used (PQ), use the following formula:
PQ = Current Output/Base-Period Productivity Ratio

40. Profit-Linked Productivity Measurement
Example: Kunkul provided the following data:
Number of motors produced 120, ,000
Labor hours used 40,000 37,500
Materials used (lbs.) 1,200,000 1,700,000
Unit selling price (motors) $50 $48
Wages per labor hour $11 $12
Cost per pound of material $2 $3

41. Profit-Linked Productivity Measurement
PQ (labor) = 150,000/3 = 50,000 hrs.
PQ (materials) = 150,000/0.100 = 1,500,000 lbs.
Cost of labor: (50,000 x $12) $ 600,000
Cost of materials: (1,500,000 x $3) 4,500,000
Total PQ cost $5,100,000
Cost of labor: (37,500 x $12) $ 450,000
Cost of materials: (1,700,000 x $3) 5,100,000
Total current cost $5,550,000
The actual cost of inputs:

42. Profit-Linked Productivity Measurement
Profit-linked effect
= Total PQ cost - Total current cost
= $5,100,000 – $5,550,000
= $450,000 decrease in profits
The net effect of the process change was unfavorable. Profits declined $450,000 because of productivity changes.

43. Price-Recovery Component
The difference between the total profit change and the profit-linked productivity change is called the price-recovery component.
Difference
Revenues $7,200,000 $6,000,000 $ 1,200,000
Cost of inputs 5,550, ,840, ,710,000
Profit $1,650,000 $3,160,000 $-1,510,000
Price recovery
= Profit change – Profit-linked productivity change
= $1,510,000 – $450,000
= $1,060,000

44. Chapter Eleven
The End