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Calculating the Cost of Poor Quality to Your Business

Posted by Rock LaManna on Wed, Apr 17, 2013 @ 09:04 AM

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Everyone talks about improving the quality of their operation.  But have you ever thought about how much “poor quality” is actually costing you?  You can find out, using a lean operations technique that helps you establish the Cost of Poor Quality.   

Why would you want to determine the Cost of Poor Quality?  It has to do with your Return on Investment for undertaking lean operations.  By establishing ROI, you overcome the two typical objections people have to improving quality:

1. I don’t have enough time.

2. I don’t have enough money.

Those objections are fair.  Any time you consider an initiative in business, there should be a cost justification to making the move, otherwise you’ll never get past #1 and #2.

That’s why when you set out to improve the quality of your organization, you should start by identifying the cost of poor quality.  “It’s how you generate ROI out of lean,” said the LaManna Alliance’s lean operations guru Ed Klaczak of EJK Consulting Solutions.

The best part about calculating the Cost of Poor Quality is that it can serve as the starting point for your quality initiatives.  It will prioritize the areas that need improvement, and give you a sense for the dollars that are at stake so you can set appropriate budgets.   

Let’s take a look at the three elements of COPQ, and how you can create metrics for each of these areas:

1. Cost of Failure

In textbook terms, the Cost of Failure involves defective products or services in the field.  It includes repair costs, warranty costs, field replacement costs – anything involved with correcting a failure.  

How does this apply to companies in the printing and affiliated fields?  Let’s use a label printer as an example.  Let’s say your customer doesn’t like the quality of the labels you just shipped, or you shipped the wrong quantity.

Any costs incurred to right that wrong, including new setup costs, shipping, and the actual run, are included in your Cost of Failure.  

You must also include the lost revenue from any print jobs that you couldn’t perform because your presses and equipment were tied up redoing the botched order.  That’s an important metric that is often overlooked by business owners.  

Other Costs of Failures are a bit more intangible, but warrant consideration.  What if the botched orders eventually result in the customer going elsewhere?  Or what if the customer decides to lambast you all over social media and at a trade show?  What is the impact to your business then?

Those are fuzzier numbers to generate, so it’s best to at least start with the costs of rerunning a botched job.   

2. Cost of Assessment

Let’s continue with the example of the botched order.  Your client has put you on double-secret probation, so you can’t afford to ship any more bad labels.  You decide to hire someone to perform inspections of each new printing job.  That’s a Cost of Assessment.

The Cost of Assessment can apply in the above example, but it also manifests in a number of other areas.  If your paper supplier ships you materials that are occasionally flawed, you may need to designate an employee to inspect the incoming materials.  That adds more to your Cost of Assessment.

Ed shared a specific example of the Cost of Assessment from his days at a large telecommunications firm.  His company had 62 inspectors for all new materials, which translated into huge fixed costs.  Working with suppliers and certifying them based on quality standards reduced the number of inspectors to 12, eliminating significant overhead. 

Your internal inspectors detract directly from your bottom line.  Ed refers to them as a  ‘non-value add’ labor.  “That’s someone who could have been producing another order (‘value-add’ labor),” he said.  “Some places will try to keep costs low and hire temps for these types of jobs, but it’s still driving up operating costs.  It drives down the return on investment.”

3. Cost of Prevention

We next move to the Cost of Prevention, which includes any and all continuous improvement efforts.  

In this case, these might include a quality management team member, a design, process or manufacturing engineer involved in preventing the failures.  These are additional resources you’re adding to right the wrong.  These people might also need new materials to fix the problem, and verify the corrective steps are working.  All these costs are outside what’s normally required to produce the product, so they are also considered incremental or ‘non-value add’ resources!

Reducing the COPQ, Boosting ROI

Mature organizations will focus on these three areas, establishing them as base metrics for their quality improvement teams.  

Even if you don’t have the resources to build your own team, establishing COPQ is a must for any organization.  It will show you exactly what issues are affecting your ROI, and by how much.  Ed has seen COPQ detract from 3 to 20 percent or more on the bottom line.  

It also helps you move from a Band-Aid management philosophy to attacking the root problem, baseline for a Continuous Improvement philosophy.  For example, if you just re-run the botched order, or struggle through the batch of defective materials, there are no guarantees you’ll be stopping a systemic problem.  

But what if you have issues in all three areas COPQ, and the financial toll is relatively the same with each problem?

Ed believes you should focus on the areas that aggravate customers the most.  “I would start by looking at the field issues and the biggest cost impacts first,” Ed said.  “Then look for in-process defects.  If you have terrible operating costs but satisfied customers, then at least no escaping defects are getting to your customer and you can then focus on internal yield improvements.  

After you have improved the internal in-process defects, you can start looking at defects from your suppliers.

One final point.  These do NOT have to be handled sequentially.  If you have the resources, then address them in parallel.  But with limited resources, start with minimizing customer defects first, then internal yield issues, then supplier issues.

With effective COPQ metrics in place, the organization can measure improvements (or degradation) over time, determine if trends and problem-solving improvements have been effective (or not) and then act accordingly.

Next month, Ed will help us examine some different ways organizations budget for their quality management programs.

Photo by: Tax Credits.

 

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