Cost Reduction through Quality Improvement

© Operational Excellence Consulting. All rights reserved.
Reducing
The Cost Of Quality

3© Operational Excellence Consulting. All rights reserved.
Learning Objectives
By the end of the program, you should be able to:
• Understand the principles and basic concepts of COQ
• Calculate COQ and conduct COQ assessments
• Identify COQ cost drivers within your organization
• Develop a COQ strategy
• Use COQ to drive prevention in your organization
• Apply COQ to manage improvement projects in your
company

Contents 2
• Phase 2: Collecting COQ Data
 Matching accounts with CONC items
 Quality costing
 COQ Data source
 Example calculations of Failure cost,
Appraisal cost and Prevention cost
 COQ scorecard and indices
 Process flow for COQ reporting
 Collecting and reporting COQ data
 Role of Finance
 Role of line managers/supervisors
 Practical guidelines
• Phase 3: Analyzing COQ Data
 Selecting quality cost bases
 Trends analysis
 Pareto analysis
 Variance analysis
 SMART criteria
 Set targets for improvement
 Case study
• Phase 4: Reducing COQ & Improving
Quality
 Reduce COQ through quality
improvement programs
 Tools and techniques
 System for quality is prevention
 Some results from industries
 Sustaining COQ

Business Case for Quality Improvement
& Cost Management
• Quality & Cost – key competitive factors
• Sustained cost advantages result from
concentration on quality
• Cost management/reduction is a continuous
process
• Inspection is a poor substitute for quality
• High cost of poor quality

Philip Crosby: Law of 10
Minimal defects due to prevention-
based activities
Defects found within the company
and corrected internally
Customer finds defects and makes
complaints
1
10
100

Impact of COQ – How a Company
Approaches It
Where we’re headed if nothing changes
• To meet PBT objectives, revenues have
to increase more than 85% in 2 years
Where we’re headed if we focus on
Avoidable Costs
• PBT objectives are met with a modest
increase in Revenues
0 1 2 0 1 2
Year Year

Link Between Quality Costing & Profits
Track quality costs
to gain top
management’s
attention
Look at high
quality cost area
Identify problem
Analyze root
cause
Take corrective
action &
Institutionalize
change
Profit & Loss
Statement
Total Cost of
Quality
Cost of Non-
Conformance
Cost of
Conformance
Prevention-based
activities
Ultimate impact
of COQ is here!

Why Measure COQ?
• Gain senior management commitment - $$$
• A scorecard with a common unit of
measurement ($, or as % of sales)
• Find areas for improvement
• Allocate resources for quality improvement
• Help set and monitor departmental quality
improvement targets
• Determine effectiveness of the quality plan

Cost of Non-Conformance (CONC)
• The costs incurred as a result of not doing
things right the first time
• Examples
 Mistakes
 Scrap
 Rework
 Equipment Downtime
 Handling customer complaints
 Warranty claims
 Customer return analysis

Quality engineering
and administration
Inspection/test (materials,
equipment, labor)
Expediting
Scrap
Rework
Rejects Warranty
claims
Maintenance and service
Cost to customer
Excess inventory
Additional
labor hours
Longer cycle times
Quality audits
Vendor control
Lost customer loyalty
Improvement program costs
Process control
Opportunity cost if sales
greater than plant
capacity
We See Only the Tip of the Iceberg
Poor quality costs a typical company
15-20% of sales annually
Less
Visible
Visible

COQ and Lean (Waste Elimination)
Waiting
Over-processing
Defects
Transportation
Motion
Overproduction
Excess Inventory
Waste Waste
Reduce COQ
by
eliminating
waste!
Input
(Man, Machines,
Materials)
Transformation
Process
(Method)
Output
(Products,
Services)

Philip Crosby on COQ
• Companies can increase their
profits by 5-10% of sales if a
proper TQM system exists
• Ideal benchmark = 2.5% of
sales

COQ Program Management
• Define a problem statement
• Define a program objective
• Identify a COQ Program Manager (PM) or manager
responsible for team of PM’s
• Provide sufficient authority to the COQ PM’s
• Align incentive throughout the company with the COQ
objectives
• Develop a process to measure progress toward the COQ
objectives
• Measure and track progress
• Recognize and reward the success of the COQ program

Four Phases of a COQ System
COQ
System
Identify
COQ
Items
Collect &
Report
COQ
Data
Analyze
COQ
Data
Reduce
COQ

PAF Model
Cost of Quality (COQ)
Cost of Conformance
( COC )
Cost of Non-Conformance
( CONC )
Prevention
Cost
Appraisal
Cost
Internal
Failures Cost
External
Failures Cost

Prevention Costs
• The costs of any action taken to investigate,
prevent the risk of non-conformity or defect
• Examples:
 Quality planning
 Quality training
 Writing of procedures and instructions
 Process capability studies
 Preventive maintenance
 Vendor assurance

Internal Failure Costs
• The costs arising within an organization due to
non-conformities or defects
• Examples:
 Scrap
 Rework
 Retest
 Re-inspection
 Redesign
 Downtime
 Overtime
 Corrective action

Seven Types of Waste
1. Overproduction
2. Excess Inventory
3. Waiting
4. Excessive Transportation
5. Unnecessary Motion
6. Over Processing
7. Defects

Waste of Lean – Excess Inventory
• Extra raw materials than are required
• Work-in-progress
• Finished goods
• Large number of equipment due to low equipment
utilization
• Material with out-dated shelf life
• Massive rework campaigns when problems surface
• Poor inventory management technique - FILO instead of
FIFO

Waste of Lean – Excessive
Transportation
• Double or triple handling
• Moving in and out of storage areas or in
between processes
• Transporting parts, materials and files or
documents around the plant or office
• Poor process flows, layouts, and workplace
organization (5S)
• Multiple sites outside of walking distance

Waste of Lean – Over-Processing
• Multiple formats for the same information
• Redundant approvals (checkers checking on
checkers)
• Lack of effective communication
• Making extra copies and excessive reporting
• Providing higher quality than is necessary

Activity 2 : Identify CONC Items
Instructions for Group
Exercise:
Map a business process in your
company and identify as many
CONC items (internal/external
failures) that you have
encountered.
Time allowed:
20 minutes

CONC Checklist 2
Process CONC Items
Marketing Sales order errors
Order entry errors
Order cancellations
Customer complaints
Product liability
Warranty
Extended warranty
Product recall
Sales concessions due to earlier mistakes
Trips to customers to explain problems
Trips to customers to resolve problems

CONC Checklist 4
Process CONC Items
Logistics Late delivery
Wrong packing
Replacements
Delivery to wrong customer
Loss due to handling and storage
Purchasing Purchasing change orders
Loss due to late supplies
Downgrading
Obsolescence
Excess inventory

3. Collecting COQ Data

Matching Accounts with CONC Items 1
Items in Accounts
Obsolescence written
off
Rent
Raw material
Finished goods
Work-in-progress
Discounts allowed
Water & electricity
Production overheads
Warranty claims
CONC Items
• Obsolescence
• Storage space
• Defects
• Spoilage
• Warranty claims
Process involved
Production/Logistics
Logistics
Production
Marketing

Quality Costing
• Whole account
• Unit pricing
• Labor/resource claiming
• Whole person

Unit Pricing
• This method is effective when a defect or
problem is recurring
• To use defect pricing, simply calculate what one
defect costs and multiply it by the number of
times it occurs

Labor / Resource Claiming
• This method involves calculating actual
expenditure on a specific activity, such as the
amount of time spent by an employee performing
a task or the amount of financial outlay for a one-
time expense
• You can gather these information from time
sheets, vouchers or any other method for
determining exactly how much was spent

Example 1: Calculating a Failure Cost Item
Cost of Re-invoicing
Whole process of re-invoicing 45 mins
Staff cost $10/hr
No. of re-invoices per annum 156 cases
Man-hours expended in re-invoicing 156 x 45 mins = 7,020 mins or 117 hrs
Total staff cost in re-invoicing 117 hrs x $10 = $1,170 per annum
Paper/invoice cost $0.28 per invoice
Postage cost $0.20 per invoice
Overheads $0.48 x 156 cases = $75
Total cost of re-invoicing $1,170 + $75 = $1,245
Relatively
small; OK
to ignore

Example 3: Calculating a Prevention Cost
Item
Cost of Quality-related Education & Training
Training in quality (including programs such $25,842
as Quality Management Course, SQAAssessor
Workshop, QC Facilitator’s Course, SPC, etc.)
Training materials (including purchase of training $3,050
packages and videos)
Miscellaneous (including man-hours spent $10,112
attending training, internal trainers fees and
overheads)
Total $39,004

COQ Scorecard (CONC Items)
External Failure Costs $’000
Complaint investigation & adjustment 43
Returns, replacements & allowances 610
Warranty expenses (rentals & repairs) 24
Liability & related legal 38
Goodwill losses 200
Total external failure costs (% of total) 915 (19%)
Internal Failure Costs
Disposition 105
Scrap 290
Rework 2,150
Retest 120
Yield losses 65
Downtime 910
Extra safety stock (carrying cost) 50
Defect-generated overtime 340
Total internal failure costs (% of total) 4,030 (81%)
TOTAL QUALITY COSTS 4,945

COQ Indices
Sales Revenue:
TCOQ * 100%
Sales Revenue
Manufacturing
Costs:
TCOQ * 100%
Mfg. Costs
Value Added:
TCOQ * 100%
Value Added
Direct Labour
Costs:
TCOQ * 100%
Direct Labour Costs
Sales Revenue:
CONC * 100%
Sales Revenue
Sales Revenue:
COC * 100%
Sales Revenue

Collecting & Reporting COQ Data
• Collect and report COQ data on a periodic
basis, e.g. monthly
• Line managers/supervisors collect raw data and
submit to Finance Department periodically
• Accounts clerk inputs raw data into computer
and churns out COQ report or scorecard

Role of Line Managers / Supervisors
• Work with Finance Department to identify quality
related activities and COQ items that need to be
monitored
• Collect data on COQ
• Analyse COQ and take appropriate corrective
actions to tackle problem areas
• Pursue a continuous policy of quality
improvement and COQ reduction

Practical Guidelines 1
Do’s Don’ts
•Have a clear purpose and strategy •Go it alone - involve other departments
•Report only costs endorsed by the Finance
department
•Expect that the existing accounting system
will provide the information needed
•Get data and costs from standard data
whenever possible
•Be too ambitious – start with a pilot study
•Start with CONC items •Expect too much during the initial phase of
implementation
•Collect those quality costs that are most
accessible
•Agonize over insignificant quality costs
•Concentrate on costs that do or can
change with improvement
•Concentrate only on what is already known

Practical Guidelines 3
• Be prepared for COQ to rise initially as people
get better at identifying them
• Attribute costs according to where they occur
• Monitor overall COQ periodically
• COQ should be gathered more accurately and
monitored more frequently for those areas
targeted for improvement

Selecting Quality Cost Bases
• Quality Cost in absolute terms
• Quality Cost in relation to some appropriate base
 COQ as a percentage of Sales
 COQ per Employee
 COQ per dollar of manufacturing cost
 COQ per unit
 and so on…

Trend Analysis

Trend Analysis of CONC Items
0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
J F M A M J J A S O
Positive trend in
CONC reduction
over time

Variance Analysis
• Variance = Actual – Target
 Example:
 FY10 Target Scrap Cost = 5% of sales
 Feb 10 Scrap Cost = 8% of sales
 Variance = - 3% of sales
• Unfavorable variance exists if:
 Actual exceeds target
 “+” = favorable variance
 “-” = unfavorable variance

Set Targets for Improvement 2
Establish an overall improvement goal for COQ reduction
(Example: “To reduce the Total COQ/Sales by 10% this
year”)
Set operational targets that will help the company achieve
its overall goals
(Example: “To reduce the cost of rework by 25% this
year” or “To reduce warranty claims by 20% this year”)
Take appropriate corrective action and monitor progress
against the targets

Case study: H&S Motors
• The H&S motor company produces small motors for use in
lawnmowers and garden equipment. The company instituted a
quality improvement program in 1999 and has recorded the
following quality cost data and accounting measures for 4 years.
• The company wants to assess its quality assurance program and
develop quality index using sales basis for the 4 year period.
1999 2000 2001 2002
Prevention 27000 28500 74600 112300
Appraisal 155000 170300 113400 107000
Internal Failure 386400 469200 347800 219100
External Failure 242000 192000 103500 106000
Total COQ 812399 862000 641301 546402
Sales 4360000 4450000 5050000 5190000
Case Study

H&S: Findings & Analysis
• Approximately 75% of the H&S’ total quality costs are a result of
internal and external failures.
• In 2000 company spent more money on product monitoring and
inspection that resulted into high appraisal cost. With this
strategy, H&S was able to identify more defective items, resulting
in an apparent increase in internal failure cost and lower external
failure cost.
• In year 2001 & 2002, company invested on prevention activities
i.e. training of employees, redesigning the production process
and planning how to build in product quality etc.
• Although prevention costs increased by more than 300 % during
the 4 year period, they resulted in a decrease in overall quality
costs.
Case Study

5. Reducing COQ &
Improving Quality

Reduce COQ Through Quality
Improvement Programs
• Top management commitment
• Quality infrastructure
• Quality improvement cycle
• Training and education
• Quality-related cost awareness
• Quality-related cost participation

Tools & Techniques for Quality
Improvement
Problem solving
techniques:
• PDCA
• A3
• 8D
• Six Sigma (DMAIC)
• etc.
Seven QC Tools:
• Stratification
• Check Sheets
• Graphs & Control Charts
• Pareto Charts
• Fishbone Diagrams
• Histograms
• Scatter Diagrams

PDCA Problem Solving Steps
Identify the Problem
Understand Present Situation
Identify Root Cause
Plan Improvement
Implement Improvement
Confirm Results
Standardise Improvement
Review & Follow Up
Step 1
Step 2
Step 3
Step 4
Step 5
Step 6
Step 7
Step 8
PLAN
DO
ACTION
CHECK

System for Quality is Prevention
• Identify cause
• Take corrective action
• Standardize
• Identify culprits
• Catch culprits
• Jail culprits

Some Results from Industries 2
Electronics Industry:
Company C:
Field returns reduced by
58% within 9 months.
Employees taking medical
leave declined by 76% within
a year.
Company D:
COQ as a % of sales
reduced by 50% within 6
months.
Cost savings of $900,000
from scrap reduction within
6 months.

Sustaining COQ
• Understand and meeting the needs of customers
• COQ is primarily a cost reduction program and must be managed as
such
• Senior management support across multiple functions is critical to
the success of COQ
• Take a holistic approach for optimum results, e.g. TQM program
• Focus on prevention, not quick fix
• Rewards and recognition
• Evaluate and improve COQ system
• Total Quality is a journey

Cost Reduction through Quality Improvement

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Cost Reduction through Quality Improvement