Reducing the Cost of Quality (COQ) by Operational Excellence Consulting

© Operational Excellence Consulting. All rights reserved.
Reducing the
Cost of Quality

© Operational Excellence Consulting. All rights reserved. 2
Objectives
Upon completion of this program, you will be
able to:
• Understand the principles and basic concepts of the Cost of Quality
(COQ)
• Understand how quality improvement reduces costs
• 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 organization
NOTE: As this is a PREVIEW, only selected slides
are shown. To download the complete presentation,
please visit: http://www.oeconsulting.com.sg

Contents 1
• Introduction & Basic Concepts
of COQ
 Business case for quality
 Impact of quality improvement program
 Link between quality costing and profits
 Why are quality costs important?
 Why measure COQ?
 What is COQ?
 COQ iceberg
 COQ versus Lean & Six Sigma
 Goal of COQ system
 Preparation
 Four phases of a COQ system
• Phase 1: Identifying COQ Items
 PAF model
 Internal failure costs
 External failure costs
 Appraisal costs
 Prevention costs
 COQ Strategies
 Financial structure P&L
 Seven types of waste
 CONC checklists
 Guidelines for identifying COQ items

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

Vicious Cycle of Poor Quality
Extensive
Reworking
Fire-Fighting
High
Defects
No Time To
Look For
Real Solutions
Poor
Quality
Unhappy
Customer
14
3 2

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!

What is COQ?
• Cost of Quality (COQ) is the total cost of
ensuring product and service quality
• Total COQ is the sum total of the Cost of Non-
Conformance (CONC) and the Cost of
Conformance (COC)
CONC COC COQ

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

Cost of Conformance (COC)
• The costs incurred in ensuring that things
are done right the first time
• Examples:
 Quality training
 Quality auditing
 Inspections and tests
 Process capability studies
 Vendor assurance
 Continuous improvement programs
 Customer satisfaction surveys

We See Only the Tip of the Iceberg
Poor quality costs a typical company
15-20% of sales annually
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
Less
Visible
Visible

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

“Eliminating what is
not wanted or
needed is profitable
in itself.”
Philip Crosby

Goal of COQ System
Elimination of Failure Costs
Reduction in Appraisal Costs
Investment in Prevention
activities/programs
COQ Strategies
To facilitate
quality efforts
that will lead
to cost
reduction
opportunities

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

External Failure Costs
• The costs occurring after delivery or shipment of the
product — and during or after furnishing of a service
— to the customer
• Examples:
 Warranty claims
 Replacements
 Customer returns
 Product recalls
 Customer return analysis
 Handling customer complaints
 Loss of customer goodwill

Internal Failure Costs
• The costs occurring prior to delivery or shipment of
the product, or the furnishing of a service, to the
customer.
• Examples:
 Scrap
 Rework
 Retest
 Re-inspection
 Redesign
 Downtime
 Corrective action
 Downgrading

CONC Checklist 1
Process CONC Items
Production Scrap
Rework
Repair and return costs
Engineering Equipment/facility damage
Equipment/facility repair
Equipment downtime
Equipment redesign/modification
Engineering change orders
Subcontractor faults
Design Product redesign
Computer downtime
Design change
Note: List is not exhaustive

“You can’t
manage what you
don’t measure.”
Peter Drucker

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
1. Whole account
2. Unit pricing
3. Labor/resource
claiming
4. Whole person

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

COQ Scorecard
External Failure Costs
Internal Failure Costs
Appraisal Costs
Prevention Costs
TOTAL QUALITY COSTS
$ %
$ %
$ %

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

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 cost of failure 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

COQ Trends Analysis
0
100000
200000
300000
400000
500000
600000
700000
800000
900000
1000000
1999 2000 2001 2002
Prevention
Appraisal
Internal Failure
External Failure
Total COQ
Case Study

“All quality
improvement occurs
on a project-by-
project basis and in
no other way.”
Joseph M. Juran

Sustaining COQ 1
• Constantly understand and meet 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. position COQ as part of a TQM program

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About
Operational
Excellence Consulting

About Operational Excellence
Consulting
• Operational Excellence Consulting is a management training and
consulting firm that assists organizations in improving business
performance and effectiveness.
• One of our unique strengths is going beyond a tools-focused
approach to seamlessly integrate people, processes, technology
and continuous improvement initiatives to suit the specific needs
and situations of our clients.
• We provide corporate learning programs and management advisory
services to assist our clients to achieve breakthrough in business
performance and effectiveness. Our aim is to support our clients in
designing, managing and executing lasting beneficial change.

www.oeconsulting.com.sg
www.oeconsulting.com.sg
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