11 -1

CHAPTER Quality Costs and

Productivity:
Measurement,
Reporting, and
Control
 11 -2

Objectives
1. Identify and describe the four types of quality
costs. After studying this
chapter,
2. Prepare a quality costyou should
report and explain the
be able
difference between to:
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.
 11 -3

Quality Defined

A quality product
or service is one
that meets or
exceeds customer
expectations...
 11 -4

Quality Defined
… on the following eight dimensions:
Performance Durability
Aesthetics Quality of
conformance
Serviceability
Fitness for use
Features
Reliability
 11 -5

Quality Defined
… on the following eight dimensions:
How consistently
Performance Durability
and well a product
The appearance
functions of
Aesthetics Quality of
tangible products
Measures
(style, the
beauty)
conformance ease of
Serviceability maintaining and/or
Characteristics of a
repairing
Fitness
product
The the use
that for product
differentiate
probability that the
Features functionally similar
product or service will
Reliability products
perform its intended
function for a specified
length of time
 11 -6

Quality Defined
… on the following eight dimensions:
The length of time
Performance Durability
aAproduct
measurefunctions
of how
Aesthetics
a product meets its Quality of
specifications
The suitability of the conformance
Serviceability
product for carrying
out its advertised
Fitness for use
Features
functions
Reliability
 11 -7

Quality Defined

A defective product
is one that does not
conform to
specifications.
 11 -8

Quality Defined

Zero defects
means that all
products
conform to
specifications.
 11 -9

Quality Defined
The definition of quality-related activities imply
four categories of quality costs: Incurred to
prevent
Incurredpoor
to
1) Preventive costs quality or
determine
services
whether beingwhen
Incurred
products
2) Appraisal costs
and Incurred
productswhen
produced
services and
3) Internal failure costs products
to doand
services
conform not
services
conform
requirements failtoto
4) External failure costs
conform to
specifications
requirements after
being delivered
 11 -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 -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
 11 -12
Examples of Quality Costs

Internal failure costs

Scrap

Rework
Downtime (defect related)
Reinspection
Retesting
Design changes
 11 -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
 11 -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

 11 -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.
 11 -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.
 11 -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.
 11 -18
The Taguchi Quality Loss Function
$
Cost

Lower Target Upper

Specification Value Specification
Limit Limit
 11 -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
 11 -20

Quality Cost Report

Unit Actual Diameter (y) y-T (y –T)² k(y-T)²
1 9.9 -0.10 0.010 $ 4.00
2 10.1 0.10 0.010 4.00
3 10.2 0.20 0.040 16.00
4 9.8 -0.20 0.040 16.00
Total 0.100 $40.00
Average 0.025 $10.00
 Image Products 11 -21
11-22
Quality Cost Report
For the Year Ended March 31, 2004
Quality Costs % of Sales
Prevention costs:
Quality training $35,000
Reliability engineering 80,000 $115,000 4.11%
Appraisal costs:
Materials inspection $20,000
Product acceptance 10,000
Process acceptance 38,000 68,000 2.43
Internal failure costs:
Scrap $50,000
Rework 35,000 85,000 3.04
External failure costs:
Customer complaints $25,000
Warranty 25,000
Repair 15,000 65,000 2.32
Total quality costs $333,000 11.90%
 11 -22

Relative Distribution of Quality Costs

External
Failure Prevention
(19.5%) (34.5%)

Internal Appraisal
Failure (20.4%)
(25.6%)
 11 -23
Quality Cost Graph
Total
Cost Quality
Costs Failure Costs

Control Costs
0
AOL 100%

Percent Defects
 11 -24

Contemporary Quality Cost Graph

Cost Total
Quality
Costs Failure Costs

Control Costs

0 100%
Percent Defects
 11 -25
Trend Analysis

Assume the following data:

Quality Costs Actual Sales % of Sales
2000 $440,000 $2,200,000 20.0%
2001 423,000 2,350,000 18.0
2002 412,500 2,750,000 15.0
2003 392,000 2,800,000 14.0
2004 280,000 2,800,000 10.0
Multiple-Period Trend Graph: 11 -26

Total Quality Costs

% of
Sales

20

15

10

0 1 2 3 4
5
Year
 Multiple-Trend Analysis for 11 -27

Individual Quality Costs

Assume the following quality cost data:
Internal External
Prevention Appraisal Failure Failure

2000 2.0%1 2.0% 6.0% 10.0 %

2001 3.0 2.4 4.0 8.6
2002 3.0 3.0 3.0 6.0
2003 4.0 3.0 2,5 4.5
2004 4.1 2.4 2.0 1.5
1
Expressed as a % of sales
 Multiple-Period Trend Graphic: 11 -28

Individual Quality Cost Categories

Percentage
10
of Sales
9
8
7
6
5
4 Prevention
3
2 Appraisal
Internal failure
1 External failure
0
0 1 2 3 4 Year
Productivity: Measurement 11 -29

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.
Productivity: Measurement 11 -30

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.
 11 -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: Outputs:
Labor
4
Capital
6
 11 -32

Technical Efficiency
Same Output, Fewer Inputs
Inputs: Outputs:
Labor
3 6
Capital

More Output, Same Inputs

Inputs: Outputs:
Labor 4 8
Capital
 11 -33

Technical Efficiency
More Output, Fewer Inputs
Inputs: Outputs:
Labor
3 8
Capital
Technically Efficient Combination I:
Inputs: Outputs:
Labor
3 8
Capital
$20,000,000
 11 -34

Technical Efficiency

Technically Efficient Combination II:

Inputs: Outputs:
Labor
2 8
Capital
$25,000,000

Of the two combinations that produce the same output,

the least costly combination would be chosen.
 11 -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.
 11 -36

Profile measurement provides a

series or a vector of separate and
distinct partial operational measures.
 11 -37

Profile Productivity Measures

Example 1:
The productivity of both labor labor and materials
moves in the same direction:
2003 2004
Number of motors produced 120,000 150,000
Labor hours used 40,000 37,500
Materials used (lbs.) 1,200,000 1,428,571
150,000/37,500
Partial Productivity Ratios
150,000/1,428,571
2003 Profile 2004 Profile
Labor productivity ratio 3.000 4.000
Material productivity ratio 0.100 0.105
 11 -38

Profile Productivity Measures

Example 2:
Assume the same data as Example 1 except the material
used is 1,700,000 pounds.
2003 2004
Number of motors produced 120,000 150,000
Labor hours used 40,000 37,500
Materials used (lbs.) 1,200,000 1,700,000
150,000/37,500
Partial Productivity Ratios
150,000/1,700,000
2003 Profile 2004 Profile
Labor productivity ratio 3.000 4.000
Material productivity ratio 0.100 0.088
 11 -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
 11 -40

Profit-Linked Productivity
Measurement
Example: Kunkul provided the following data:
2003 2004
Number of motors produced 120,000 150,000
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
 11 -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
The actual cost of inputs:

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
 11 -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.
 11 -43
Price-Recovery Component
The difference between the total profit change and the
profit-linked productivity change is called the price-
recovery component.
2004 2003 Difference
Revenues $7,200,000 $6,000,000 $ 1,200,000
Cost of inputs 5,550,000 2,840,000 2,710,000
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
 11 -44

Chapter Eleven

The End
11 -45